State Street Global Advisors, the fund sponsor behind SPY, the
first and biggest U.S. ETF, filed regulatory paperwork to gain
permission to market nontransparent, actively managed
that is essentially identical to paperwork iShares'
parent BlackRock Inc. filed in the summer of 2011 and the one
Precidian Investments submitted early this year.
Unlike already-live transparent active ETFs-like Bill Gross'
nearly $5 billion Pimco Total Return ETF (NYSEArca:BOND)-SSgA's
"exemptive relief" petition to the SEC is asking to market ETFs
that have periodic portfolio disclosures, such as those the SEC
requires for mutual funds. In fact, the SSgA petition is based on
the very same patent as the BlackRock and Precidian proposals.
At the center of State Street's proposal is a blind trust that
works on behalf of the authorized participant (
) that would keep disclosure of portfolio holdings under wraps
until regulators require it. Existing mutual funds must disclose
holdings every three months with a lag, and it appears that the new
plan, if approved by the SEC, would include disclosure requirements
similar to those in place for mutual funds.
State Street noted in the paperwork that it has three separate
nontransparent, active funds in mind in the event the Securities
and Exchange Commission does approve the petition. Those funds
- SPDR SSgA Equity ETF
- SPDR SSgA Emerging Markets ETF
- SPDR SSgA Aggregate Bond ETF
State Street's plans, and those of BlackRock and Precidian, are
part of a broader trend in the world of ETFs to offer up a
mechanism that would allow fund companies to seek outperformance
with actively managed strategies that enable mutual fund managers
to keep portfolio holdings under wraps long enough to profit from
ostensibly superior ideas.
Other such plans similar in spirit, though different in
structure to what SSgA is proposing, are those for the
nontransparent ETFs the mutual fund company Eaton Vance has in the
works. Eaton Vance proposes bringing to market exchange-traded
managed funds, or ETMFs, that make use of what it calls "NAV-based
All these nontransparent active ETFs stand in sharp contrast to
the vast majority of existing ETFs, which are indexed vehicles.
Indeed, more than 99 percent of the $1.5 trillion invested today in
U.S.-listed ETFs is in indexed vehicles, with the remainder in
funds like Bill Gross' BOND, which is active but must disclose
portfolio holdings daily.
BOND is the most successful active ETF to date, but some
industry sources believe that if State Street's nontransparent
active plans are approved, many mutual fund companies that have
made tentative steps to begin offering exchange-traded funds might
leap head-first into the ETF business if they could keep their
portfolio disclosures to a minimum, as they do now.
Under the plans proposed by State Street, BlackRock and
Precidian, APs for such nontransparent active ETFs would
effectively be doing creations and redemptions for cash and hedging
the funds based on the fact that they could redeem shares for the
exact cash value of the funds' net asset value (
Creations and redemptions would happen in kind in the blind
trust, allowing the fund to enjoy some of the tax efficiencies that
transparent ETFs currently enjoy.
Crucially, the blind trust would be able to do what APs at the
center of any index-based ETF are able to do, such as eliminating
higher-cost securities to get rid of imbedded capital gains at the
fund level. Such cherry-picking of securities is a key reason ETFs
are considered to be more tax efficient than mutual funds.
Regarding creations in the proposed structure, the State Street
filing-with the exact same language as the BlackRock
"Since Creation Units will be created solely by the deposit of
cash and will typically be redeemed by distributing securities of
the fund's portfolio to a blind trust that will liquidate the
portfolio securities in accordance with instructions from the
authorized participant redeeming shares, neither the adviser nor
the fund sub adviser will be able to cause an authorized
participant to engage in transactions in which the funds could not
engage directly or to otherwise use the in-kind process to
circumvent applicable restrictions under the Act."
Also, when ETF shares are liquidated, the AP would receive
cash-again, never knowing what made up the ETF shares that the
blind trust redeems.
Crucially, the blind trust becomes a part of the creation and
redemption mechanism that is at the center of how an ETF
Because that aspect remains the same, that means tax
inefficiencies and cash drag that are the Achilles heels of many
mutual funds are likely to be neutralized under the proposed
When faced with redemptions, the fund would have two choices of
response:It could raise cash at the fund level if it has a loss it
wants to lock in for tax reasons, or it could hand out shares
in-kind to the blind trust that would then liquidate shares on
behalf of the AP.
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