ETMF: A Mutual Fund in an ETF Wrapper?

The $2.6 trillion global ETF industry is dominated by passively managed funds that track an index. Their low cost and transparent structure are the main reasons for their massive popularity. There are only a handful actively managed ETFs and very few of them have been able to win investors’ favor.

One of the main reasons why actively managed strategies could not gain traction within the ETF world is the requirement for disclosure of daily portfolio holdings, which has the potential for facilitating “front-running” of portfolio trades. This rule puts actively managed ETFs at a disadvantage to similar mutual funds, which are required to publish their holdings only on a quarterly basis.

A new development could now be a potential game changer for actively managed ETFs. Last week, the SEC approved a new type of fund structure—an Exchange Traded Mutual Fund (:ETMF)--a hybrid between an ETF and a mutual fund also popularly being referred to as “non-transparent” ETF. The approval granted to the asset manager Eaton Vance marks a surprising reversal of the SEC’s earlier ruling rejecting Blackrock’s and Precisian’s proposals for somewhat similar funds.

The new product will be branded as “NextShares” by Eaton Vance and we expect to see some launches in the coming months.

A Mutual Fund within an ETF Cover

Like ETFs, ETMFs will list and trade on exchanges and primarily utilize in-kind transfers of portfolio positions in issuing and redeeming creation units. Like mutual funds, ETMFs would be bought and sold at prices linked to NAV and would not be required to disclose their portfolio positions on a daily basis. (Read: ETFs vs. Mutual Funds)

How do Investors benefit from this Structure?

· Lower Operating Costs: ETFs in general have a cost advantage over similar mutual funds simply due to the way they are structured. Most mutual funds charge their investors transaction fees, transfer agency charges and distribution charges. Per NextShares, these charges and cash drag together added up to more than 75 basis points annually on an average from 2007 to 2013.

· Enhanced Tax Efficiency: Investors stand to benefit from the tax advantages resulting from in-kind exchanges, which create no tax implications. Further, (Read: Most ETFs are Tax Smart, Is Yours?)

· Exchange Trading at NAVs: ETMs will be convenient to buy and sell on exchanges at prices close to their NAVs.

· Potential to Outperform: ETMFs will seek to outperform their benchmarks over time using the manager’s expertise and insights. And by not having to disclose their “secret sauce” everyday, they have better chances of doing so.

While it remains to be seen whether these products will become popular with investors, the developments is certainly a major milestone for the ETF industry.

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