Mid-November’s announcement by the US Securities and Exchange Commission of the intention to approve novel ETF structures included the Shielded Alpha ETF wrapper from Blue Tractor Group.
Brain child of Blue Tractor founder Terry Norman, Shielded Alpha brings ‘less than fully transparent’ ETFs to the market by disseminating to the market a daily creation basket which will consist of 100 per cent of the securities in the fund’s actual portfolio but not their correct portfolio weightings.
The alpha generation strategy underlying the actively managed ETF is, the firm says, fully obscured by this mis-match in securities weightings and the creation basket weightings will also have a minimum 90 per cent asset value overlap with the ETF’s actual portfolio weightings at the beginning of each trading day.
Blue Tractor says that as a result of these creation basket characteristics a Shielded Alpha ETF would not be a non or semi-transparent ETF like the wrapper structures developed by rivals Precidian, Natixis/NYSE, Fidelity and T Rowe Price, but rather a highly transparent ETF – yet, the firm says, one that still completely hides the alpha generation strategy of the fund.
The Shielded Alpha proprietary algorithm and all the workflow needed to generate the creation basket is hosted in the cloud and the Blue Tractor platform offers fund managers software tools to manage the creation basket to maximise cost and tax efficiency and to hide portfolio trading execution. Blue Tractor believes that in order to maximise alpha, best-in-class advisers will manage both their ETF portfolio and the fund’s creation basket.
Norman, a veteran developer of quantitative alpha generation programs for financial firms in London and the US, came up with the idea for the Shielded Alpha ETF wrapper while riding his blue tractor, cutting hay on his farm outside of London.
Blue Tractor’s co-founder Simon Goulet, a former investment banker in Toronto and New York, focuses primarily on Blue Tractor’s business and corporate development. Based in New York City, Blue Tractor filed its initial approval application with the SEC in 2016 and its business model is to license the Shielded Alpha ETF wrapper to third-party active managers.
Norman says: “The Shielded Alpha ETF wrapper completely shields an active manager’s alpha generation strategy, but also embraces what has made ETFs so successful – their transparency. What differentiates our structure from competitive structures is that all the names in the underlying portfolio are visible, so investors, advisers and market makers can see what they are exposed to, which is of paramount importance in less liquid and highly volatile markets.”
Norman stresses however that the weightings in the creation basket will not be materially different from the actual undisclosed portfolio, so as not to create any concentration of risk in any one security.
Blue Tractor developed its structure by interfacing with market makers and other ETF capital market participants, Goulet (pictured) says. “The first question from potential licensees is what does the market making community think about the structure, so we are very comfortable talking about that because of our deep relationships within that community.”
The company claims that the highly transparent Shielded Alpha structure is ‘inherently superior to the non or semi-transparent ETF wrappers developed by rival firms’.
The firm writes that the Natixis/NYSE, Fidelity and T Rowe Price structures rely on what is termed a ‘proxy portfolio’ creation basket, where the basket can add decoy securities or omit securities that are in the actual portfolio.
And the non-transparent wrapper developed by Precidian does not publish a creation basket, relying on a third-party entity called an authorised participant representative that transacts on behalf of the market because it has confidential knowledge under a non-disclosure agreement of the actual ETF portfolio.
Blue Tractor argues that none of these structures provides market makers with the transparency required to conduct efficient markets under all trading conditions and market volatility.
Blue Tractor’s licensing fee is calculated as a basis points royalty dependent on total assets under management and the rate will be competitive for early adopters.
Norman says: “We have an incentive for first movers and as their asset grows we provide additional incentives in the form of a lower basis point rate.”
The pair anticipate that by late 2020 the US ETF market could see the first Shielded Alpha ETFs issued by licensees. Goulet says: “Our target licensee is a mutual fund company that has seen its assets leave and go into ETFs. The Blue Tractor wrapper captures the advantages of an ETF, such as lower cost, greater tax efficiency and intra-day liquidity versus a mutual fund, but still allows the fund manager to fully cloak their alpha generation strategy.”
Norman believes that once the current structure has proved itself with US equity and foreign equity securities that trade contemporaneously with the US markets, they will ask the SEC to allow fixed income instruments and securities from Europe, Australia and Asia.
“Watch this space for potentially exciting developments in Ireland for European ETFs ,” Norman says. “We are talking to ETF consultants as the Bank of Ireland has signalled it is closely monitoring the changes in the US regarding non or semi-transparent ETFs.”