NextShares’ New Product Combines Active Management With ETFs

The mutual fund industry's latest attempt to deal with the rising threat of the exchange traded fund comes from Eaton Vance ( EV ).

On Friday, the Boston fund giant's subsidiary, NextShares, launched a brand new structured product called an exchange traded managed fund, or ETMF, a hybrid that combines what some consider the best parts of the actively managed mutual fund with an ETF.

The first ETMF, Eaton Vance Stock NextShares ( EVSTC ), invests in the same portfolio as $95 million Eaton Vance Stock Fund ( EAERX ), an equity mutual fund that holds mostly large U.S. stocks. Both are managed by Charles Gaffney. The mutual fund has outperformed the S&P 500 index for the past one-, three- and 10-year periods.

Most ETFs are passive funds that track an index, which helps keep operating costs very low. But a few mutual fund and ETF companies have tried to grab investors who want to beat the market by launching more than 100 actively managed ETFs. So far, they've gained little traction. Active ETFs hold less than 1% of the $2 trillion in U.S. ETFs.

The big problems with the active ETFs are higher costs and transparency. Because ETFs must post their portfolios daily, active ETFs are subject to front-running by other traders, which can hurt returns.

"The exchange traded managed fund is not an actively managed ETF; it's a new type of fund," said Stephen Clarke, president of NextShares Solutions. "Actively managed ETFs are not protective of confidential portfolio information. The majority of active mutual fund managers have been unwilling to introduce their best strategies in that structure."

NextShares solves that problem by letting managers hide the details of their strategy for beating the market. Like a mutual fund, it only discloses its portfolio after the end of each quarter.

Like ETFs, NextShares trades on an exchange and has potential cost and tax-efficiency benefits that should provide better returns than comparable mutual funds. It should have a lower operating expense because of much lower transfer agency fees and no 12b-1 fee. Yet, EVSTC charges an expense ratio of 0.65%, just eight basis points lower than the 0.73% charged by Eaton Vance Stock Fund.

Also like an ETF, the ETMF doesn't buy shares directly from the stock exchange, so it doesn't pay transaction costs to get or remove securities when investors buy or sell shares. Instead, the ETMF trades securities with an in-kind trade, which is the basis of ETFs' famed tax efficiency. The in-kind trade avoids the capital gains mutual funds incur when they sell stock. The in-kind trade also means the ETMF doesn't have to hold cash for shareholder redemption. It can be fully invested, avoiding the cash drag that hurts returns when the stock market rises.

Mutual funds trade at net asset value ( NAV ), which is set at the end of each day, when the value of all holdings minus fees is calculated. ETFs trade on stock exchanges throughout the day. NextShares, using NAV-based trading, also trades throughout the day, but discounts or premiums to NAV are used to determine the final transaction price at day's end when the NAV is set.

NextShares are only sold by one brokerage, Folio Investing.

"They have a high hurdle to overcome by launching one product on one platform," said Todd Rosenbluth, director of ETF and mutual fund research for S&P Global Market Intelligence. "NextShares needs to show how something that seems complicated can perform in an effective way. They need to show volume, that it can be executed, and that there is a performance benefit to these products."

NextShares has received approval to launch 18 funds, and it plans to launch two more in March.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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