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Simon Goulet, Red Gate Advisers

Semi-transparent ETFs move closer to working with hedge funds and opening in Europe


The US’s semi-transparent ETF structure arrived in the sector early last year, with a bit of a fanfare, as American Century successfully launched two ETFs using Precidian Investments’ ActiveShares methodology.

The US’s semi-transparent ETF structure arrived in the sector early last year, with a bit of a fanfare, as American Century successfully launched two ETFs using Precidian Investments’ ActiveShares methodology.

Other products have followed, but universally, the thinking behind the development of the semi-transparent structure was to allow active funds, who wished to keep their trading and their holdings discrete, to launch an ETF. The ETF is famously transparent, and for some fund managers with highly sensitive proprietary trading models and intellectual property concerns, that is not such a good thing. 

Various models of semi-transparent ETF have since arrived on the market, among them the Blue Tractor model, which works slightly differently from the others, allowing the whole portfolio to be seen, but keeping the proportions of the holdings shielded. Blue Tractor was recently the first semi-transparent ETF listed by Nasdaq, and the first REITs ETF within the semi-transparent structure, and has two ETFs using its structure at the moment. 

It is Blue Tractor that has now filed an application with the SEC to apply its semi-transparent approach to long/short funds.  

Simon Goulet, co-founder Blue Tractor Group explains: “When the whole GameStop debacle happened in January 2020 and two hedge funds lost billions thanks to the Robin Hood army, I got to thinking that a lot of active managers employ long/short strategies.” 

When the SEC approved the semi-transparent structure, it precluded any short strategies in the investable universe, along with leverage, margin or options use or shorting, Goulet says. 

“We can fit short strategies into our current exemptive relief without employing leverage or options but it has to be through physical shorting and the short premium stays in the fund as collateral.” 

Blue Tractor is optimistic that their application will be approved in 2021. “It will offer more choice to advisers and to hedge funds that are interested in using a semi-transparent ETF wrapper, allowing them to go both long and short, while at the same time, providing market makers with sufficient information to price and hedge their risk, thanks to the high degree of transparency with the Blue Tractor ETF wrapper.” 

Dave Shastri, Chief Strategy Officer, at Truss Edge, a firm that offers fund operation services to both ETFs and hedge funds, recently spoke at an event on hedge funds explaining how they could launch an ETF version of themselves, and was surprised by the large amount of interest from hedge funds. Shastri says:  “We’ve had a good number of enquiries on this topic since last autumn, primarily from US managers but also some European managers.   

“This has included firms with active strategies and even some with intra-day re-allocations.  We have spoken with half a dozen firms to provide specific guidance.  Hedge funds have struggled for new capital even though they have performed well recently.  ETFs have by contrast shown strong growth in capital and this certainly plays a part in the interest by managers to explore an ETF wrapper.” 

A number of developments in the ETF industry has paved the way to this expansion of their original remit, 20 years ago, of offering a passive market cap replication of a large equity index. 

2019 saw the arrival in the US of 6c-11, the ETF Rule, a rule adopted by the US’s SEC that allowed ETFs that meet certain conditions to go to market without the delay of obtaining an exemptive order. The rule also made custom creation/redemption baskets available for all ETFs. The rule made it easier, quicker and cheaper for ETFs in the US to launch on all sorts of investment pool. 

Early 2020’s period of extreme market volatility gave the ETF wrapper its chance of demonstrating how robust the structure is, proving itself well able to maintain accurate pricing despite volatile markets.   

The result has been a greater interest in all sorts of funds converting to the ETF model, or adding the ETF model into its offering.  

David LaValle, CEO of index provider Alerian says: “Time and time again, the ETF wrapper proves to be a vehicle that can really offer investment on portfolios that have historically not been available to the broadest range of investors and hedge fund replication strategies is another version of this story we have told so many times.” 

LaValle believes that we are at a unique juncture in the ETF’s evolution with regulatory changes that have levelled the playing field. 

“Many large asset managers are not sure how to manage their active mutual fund franchises, how to put a long/short strategy into a fund with ease because of the risk of leakage or the secret sauce being let out and now asset managers can contemplate multiple structures,” he says. 

Ben Slavin, Global Head of ETFs, Asset Servicing, BNY Mellon agrees: “It is very clear that the market is demanding the delivery of investment strategies in the ETF wrapper whether a hedge fund or a mutual fund but the trend line continues to be clear.” 

Slavin notes that in the case of hedge funds, there have been attempts in the past to try and convert from a hedge fund to an ETF. “I have been personally involved over a few years ago in how to do that and there are a few different things to think about,” he says. 

“Now the difference is that the path to converting is clearer, as the ETF rule, 6c-11, allows for fully transparent active funds and exemptive relief, unless you are doing something out of the ordinary, is not necessary, so it is quicker, cheaper and easier for a hedge fund to convert and now with the semi-transparent structure, there is another tool or path that hedge funds can choose to go down” 

Slavin believes that this may be a catalyst which encourages hedge funds or LPs to make that conversion. 

“I do think there are a few important qualifications but it does open up the pool for additional assets to come to ETFs,” he says. 

“But I do think it will be a slow build in terms of the managers or funds making the conversion. The road map is not easy and comes with significant effort and cost and not all products are suitable for ETFs.” 

Slavin also warns that some investment strategies don’t port well into the ETF wrapper. “It may not make sense from a regulatory standpoint, but it also might be problematic in terms of business reasons, such as the performance track record,” he comments. “Will it remain intact? And fees are critical, especially if it’s a 2 and 20 hedge fund versus the ETF, what will the ETF charge to be competitive?” 

Since the arrival of the semi-transparent model for ETFs in the US, the question for Europeans has been whether the model could launch in Europe.  

Ireland is the dominant European domicile for ETFs and Brian Higgins, partner, Dillon Eustace in Dublin, explains that, currently, the requirement remains in Europe for ETFs to disclose their portfolio holdings daily which continues to act as a barrier to managers wanting to launch active equity ETFs.  

“The Central Bank of Ireland’s (the Central Bank) current position is that it ‘will not authorise an ETF, including an active ETF, unless arrangements are put in place to ensure that information is provided on a daily basis regarding the identities and quantities of portfolio holding. The arrangements must be disclosed in the prospectus’,” Higgins explains.  

“However, this position pre-dates the SEC’s approvals of a number of well-publicised semi-transparent ETFs structures,” he says.  

“The Central Bank continues to monitor international developments and engage with stakeholders (including regulators such as the SEC). There is a hope that this engagement will result in the Central Bank’s position evolving and that it may in the reasonably near future approve active structures by imposing requirements similar to those seen in the US such as (a) the provision of full portfolio disclosure to a restricted group of recipients including regulators, stock exchanges and (where bound by confidentiality) Authorised Participants, or  (b) the publication of the constituents of the ETF without providing the actual weightings of each constituent or (c) the use of a ‘proxy basket’.” 

However, Higgins warns that the fragmentation in the listing requirements in different European jurisdictions will remain a point of contention and is a matter which would also need to be addressed within Europe. 

Marie Coady, Global Head of ETFs at PwC also comments that European regulators are examining the semi-transparent ETF structure. “It is understood that the European Regulators are looking at this, in particular, the Central Bank of Ireland as the lead Regulator of ETFs in Europe,” she says. 

“Given the SEC approval of a number of non-transparent active models for US ETF issuers in 2019, combined with the launch of 28 non-transparent active ETFs in 2020 with approximately USD1.3 billion AUM as of March 31, 2021, there are data points to consider with respect to liquidity, trading volumes, bid/ask spreads, number of brokers trading, performance history, disclosures, compliance, etc.” 

She compares the situation with other ETF markets. “When we look at other ETF domiciles, Canada, for example, does not require daily disclosure and has a very large active ETF market with at least 25 per cent of AUM in active ETFs.  

“Australia has approved forms of non-transparent ETFs over the past year. Therefore, it is timely for a fresh consideration of the thinking in Europe given how far this topic has moved in the other key global ETF domiciles since the European industry last considered the point in detail during the industry wide ETF consultation led by the Central Bank of Ireland in 2018.” 

However, Coady warns that it is not as simple as looking to the US non-transparent active ETF models, some of which just recently reached one year of operations, and trying to replicate these models in Europe.  

Echoing Higgin’s comment on the fragmentation of the European ETF market, she says: “The governing European fund regulations are different, the market infrastructure is considerably different, so any change in portfolio disclosure rules does need careful consideration by the Regulators.” 

ETF Express is working with its sister publication, Hedgeweek, on an agenda to discuss the pros, cons and routes of wrapping a hedge fund in an ETF wrapper. To be involved, contact Jamie Home – 

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