Diluting The Brand

iShares filed recently with the Securities and Exchange Commission to expand its actively managed ETF range in the US. Up to now, such funds have had to meet with an SEC requirement to disclose positions with a one-day lag. However, according to Bloomberg, both iShares and Vanguard (which so far has not ventured into actively managed ETFs) are pushing for this requirement to be relaxed and for a portion of the assets to remain hidden from end-investors.

According to Bloomberg’s Christopher Condon, the SEC’s investment management head, Andrew Donohue, is sceptical. “I’m concerned that the lack of transparency will disrupt the process that keeps a fund’s per-share net asset value and share price closely aligned,” Donohue is quoted as saying. As last month’s flash crash showed, the arbitrage mechanism that is supposed to keep ETFs’ prices in line with the value of their underlying holdings cannot be taken for granted.

The reasons for wanting to limit disclosure are obvious: actively managed trading positions disclosed with such a short time lag (as opposed to positions bought to track a passive index, whose holdings are public knowledge) leave a fund open to being front run by the rest of the market.

In the case of Pimco’s enhanced short maturity strategy ETF, the US market’s largest actively managed fund, the risks of disclosing positions are greatly reduced by the ETF’s focus on highly liquid, short-maturity government and investment grade bonds. Take daily disclosure into the equity markets, longer-dated credit markets or pretty much any other asset class, and you’d be asking for trouble, however.

In Europe, where disclosure requirements are less stringent, we already have the phenomenon of hedge fund ETFs, where you can see a summary of strategies but not individual trades. db x-trackers, Marshall Wace and an Austrian futures trading firm called QBasis are all promoting packaged hedge fund strategies that they call ETFs – complete with steep hedge fund fees. Offering daily liquidity differentiates them from a sector that has typically offered only monthly or quarterly subscriptions and redemptions. However, you are reliant on the fund provider to price the fund correctly on a daily basis, since you can’t see through to the underlying trading positions.

In iShares’ case, going down the active fund route doesn’t appear to have been a unanimous decision at the company level. In an April report in the Financial Times, the CEO of iShares International, Rory Tobin, described the ability to calculate a fund’s net asset value on a real-time basis (intraday) as a key characteristic of ETFs. The company’s US product developers appear to disagree. A spokesperson for the firm’s European operation said that the firm has no immediate plans to launch actively managed funds this side of the Atlantic, while explaining the active ETF push in the US as a response to retail demand.

In Vanguard’s case, if Bloomberg’s report of an application to US regulators to loosen ETF disclosure requirements is correct, then this sits somewhat uneasily with the company’s reputation for seeking transparency at all costs.

Very big business interests are at stake here, with billions of dollars in investment management revenue in play. The potential gains to active managers from relaxing disclosure requirements for ETFs’ underlying positions are clear. Such a step would allow them to rebrand funds as ETFs and thereby benefit from the exchange-traded fund boom. But aren’t the ETF managers who have built such successful businesses over the last decade on the virtues of fund transparency now playing fast and loose with their brand names?

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