Eaton Vance seeks to launch actively managed ETFs

Apr 1st, 2013 | By | Category: ETF and Index News

Eaton Vance has filed an application with the US Securities and Exchange Commission (SEC) seeking authorisation to launch a family of actively managed exchange-traded funds (ETFs). The funds, which Eaton Vance calls exchange-traded managed funds, or ETMFs, are designed to bring the cost and tax efficiencies and shareholder protections of ETFs to active investment strategies, while maintaining the confidentiality of current portfolio trading information.

Eaton Vance seeks to launch actively managed ETFs

Eaton Vance has filed an application with the US SEC to launch a family of actively managed ETFs.

If approved, the proposed fund structure could provide a model facilitating the widespread roll-out of active ETFs, which, until now, have been slow to gain traction owing to reservations from active managers to fully disclose portfolio holdings.

The endorsement of the exchange-traded fund structure from Eaton Vance, one of the oldest investment managers in the United States, further reflects the ascendancy of ETFs and adds to the growing acknowledgement of the benefits ETFs offer over traditional mutual fund structures.

According to the SEC filing, ETMFs will trade on an exchange (the Nasdaq Stock Market has been selected as the listing venue for Eaton Vance’s initial offering) at prices directly linked to the fund’s next-determined daily net asset value (NAV), using what is referred to as “NAV-based trading.” In NAV-based trading, prices would vary from NAV by a market-determined premium or discount, which may be zero. However, because ETMFs would provide market makers with opportunities to earn reliable arbitrage profits without intraday hedging of their inventory positions, they can be expected to trade at consistently tight spreads to NAV in the absence of full holdings disclosure.

This aspect, which relates to the way shares are purchased or redeemed via creation units, highlights the main difference compared to conventional passive ETFs. Instead of exactly replicating underlying portfolio holdings, an ETMF’s daily creation/redemption basket would be specified by the ETMF at the beginning of each business day and would normally vary from the current portfolio holdings as required to maintain the confidentiality of its current trading activity. Securities that the investment manager is in the process of acquiring will generally not be represented in the basket until their purchase is completed. Similarly, securities currently held, but in the process of being sold, may not be removed from the basket until the sale is substantially completed. The basket may also include proportionately more cash, with such additional cash substituting for portfolio holdings that are not included in the basket.

Active managers, such as Eaton Vance, have to date largely avoided introducing their strategies as transparent ETFs because the required daily holdings disclosures can facilitate front-running of portfolio trades and enable copycat investors to replicate a fund’s portfolio positioning. This has especially been the case with equity managers. By removing the requirement for daily portfolio transparency, the new structure would enable investors to access a broad range of active strategies through a vehicle that provides much of the investor benefits of an ETF.

Thomas E. Faust, Jr, Chairman and Chief Executive Officer of Eaton Vance, said: “Eaton Vance views ETMFs as a significant progression in the evolution of actively managed funds to a lower-cost, better-performing and more shareholder-protective structure. We see ETMFs as having the potential to transform the delivery of active fund strategies in the same way that ETFs have changed how index fund strategies are bought and sold.”

Initially, the Boston-headquartered firm seeks to launch a range of ETMFs that mirror existing Eaton Vance mutual funds. However, the firm also plans to license the underlying intellectual property to other fund groups through its subsidiary Navigate Fund Solutions, thereby allowing other active managers to roll out exchange-traded versions of existing mutual funds.

Stephen W. Clarke, President of Navigate Fund Solutions, said: “Navigate Fund Solutions and Eaton Vance expect ETMFs to reliably generate 50 basis points or more of improved annual returns versus similar mutual funds across a range of strategies, reflecting lower operating expenses and reduced flow-related trading costs in the ETMF structure. Through use of in-kind redemptions, ETMFs can also achieve levels of tax efficiency similar to ETFs.”

Eaton Vance, which currently manages around $250 billion in assets, joins a growing list of traditional mutual fund managers planning actively managed ETFs. These include Charles Schwab, Deutsche Bank, Dreyfus, Federated Investors, Fidelity, Franklin Templeton, John Hancock, JP Morgan, Legg Mason, Natixis, Neuberger Berman, Principal Financial and T. Rowe Price.

Pimco, the giant fixed income specialist, has already pushed ahead with a series of actively managed ETFs, including, most notably, the Pimco Total Return ETF (BOND) managed by Bill Gross. This fund, which replicates Pimco’s flagship strategy and fully discloses portfolio holdings, has accumulated assets of almost $4.6 billion since making its ETF debut in February 2012. However, the desire to disguise or cloak portfolio holdings is less pronounced in the fixed income space, where the opaque nature of over-the-counter transactions largely protects managers from the dangers of front-running.

In the UK, a number active fund management groups, including London branch offices of some of the aforementioned international firms, are understood to have considered the prospects for local active ETF launches. They will no doubt be watching closely to see how the US market evolves. Variations of active ETFs do, however, already exist in the UK in the form of the Man GLG Europe Plus Source ETF (MPFE) from Source and Man GLG and the db X-trackers SCM Multi Asset UCITS ETF (XS7M) from Deutsche Asset & Wealth Management and SCM Private. These funds fully disclose their daily portfolio holdings, but, because they are highly diversified and follow proprietary processes involving discretionary elements, front-running is deemed difficult or ineffective. While these funds demonstrate that the active ETF model can work, perhaps more encouraging is the success of the Man GLG ETF. It has gathered more than €700 million in assets, providing a clear indication of investors’ willingness to adopt active ETFs.

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