A new breed of exchange-traded vehicle has entered the arena, combining the best of ETF benefits with the so-called “secret sauce” of actively managed mutual funds.
Read on below for a cursory tour of the recently debuted Exchange-Traded Managed Funds (ETMFs) to learn more about their similarities to and differences from ETFs.
The premise behind this product structure is simple: it is an investment vehicle that merges traditional active management, as in the form of an open-end mutual funds, with the more efficient ETF wrapper.
Put another way, this product structure aims to harness the “alpha-seeking” approach of active managers by leveraging the proven, more cost-effective ETF trading mechanisms.
Let’s dive into the details:
Similarities to ETFs
- ETMFs make use of authorized participants; this is one of the underlying features that leads to a cheaper expense ratio when compared to their mutual fund peers that inherently incur more expenses around an internal trading desk, agent fees, and other portfolio management functions.
- ETMFs rely on the same creation/redemption mechanism that powers ETFs; this is a key feature that translates into tax efficiency, among other benefits.
- ETMFs trade on the secondary market just like ETFs, and unlike mutual funds which lack intraday tradability.
- ETMFs offer a single, low-cost share structure with no sales loads or embedded distribution and service fees; this is contrary to the mutual fund industry, which is synonymous with several share classes and varying expense structures, including the infamous 12b-1 fees.
Similarities to Mutual Funds
- ETMFs are nontransparent; this means that unlike ETFs, which report their holdings on a daily basis, these funds are only required to do so once a quarter, with a 60-day filing lag on top of that. This is a key point that appeals to active managers fearful of other market participants front-running their strategies as a result of the required daily disclosure of their portfolios.
- While they can be bought and sold during the day like ETFs, ETMFs will be priced after the close, similar to their mutual fund peers. The prices of these vehicles are linked to the fund’s next daily NAV and determined after NAV is computed at end of the day. Read more about the unique “NAV-based trading” mechanism.
To summarize, ETMFs bear a great deal of similarities to both ETFs and mutual funds, although a few key features stand out from the list. For starters, ETMFs trade intraday like ETFs, but their prices are quoted once a day like mutual funds. Second, ETFMs are built like ETFs behind the scenes, which allows for reduced portfolio management expenses on the part of issuers. This translates into reduced fees when compared to mutual funds.
Third, ETMFs adhere to the same portfolio transparency reporting standards as mutual funds, meaning that they don’t post their holdings daily like ETFs, but instead do so quarterly.
Last but not least, ETMFs are offered in limited distribution channels for the time being. This means that you can’t just login to your retail brokerage account (like Fidelity or Scottrade) and buy one as you would with an ETF; for now, the only means of trading ETMFs is through broker-dealer Folio.
A Mixed Reception on Wall Street
Since late 2014, when the SEC officially granted long-awaited exemptive relief to Eaton Vance, making way for the first wave of exchange-traded managed funds, most investors have fallen into one of two camps. They either think the product structure is great, or they think it represents everything against which ETFs stand.
On the pro-ETMF side:
- ETMFs are opening the doors to more active managers and more investors in search of alpha-generating instruments.
However, the critics point out that:
- These vehicles are designed to conceal the “secret sauce”, which makes them unappealing to die-hard ETF investors who embrace total transparency.
- There is a lot of uncertainty around the pricing of these vehicles, which makes unusable for traders and is a big concern for those used to equity/ETF-like intraday liquidity.
Given the hybrid structure, it’s no wonder really that ETMFs are the cause of much debate in the ever-evolving funds industry.
ETMF Issuers and Products
The first ETMFs were launched by Eaton Vance under the NextShares product suite in February of 2016 on the Nasdaq exchange.
The list of ETMF sponsors that plan to operate funds through the NextShares umbrella include:
- ALPS Advisors
- American Beacon
- Broms Asset Management
- Columbia Threadneedle Investments
- Gabelli Funds
- Hartford Funds
- Ivy Funds
- Nile Capital Management
- Pioneer Investments
- Principal Management Corporation
- Victory Capital
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The Bottom Line
At their core, these vehicles offer the potential benefits of protecting the confidentiality of the portfolio holdings/strategy, as with traditional mutual funds, while doing so in a cost-effective manner, by utilizing mechanism core to the ETF structure. The development of ETMFs at the very least marks yet another stride forward in making investment strategies of all walks more accessible to retail investors.
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