Active managers could turn toward exchange traded managed funds, or ETMFs, to lower costs and capitalize on the tax efficient structure.
Eaton Vance’s Navigate Fund Solutions unit has received SEC approval to offer the new type of ETMFs under the NextShares brand. The ETMFs will combine some of the best features of ETFs and traditional actively managed open-end mutual funds, according to Scott Cooley, Director of Policy Research with Morningstar.
ETMFs are a new concept that marry the liquidity and tax efficiencies that have attracted investors to ETFs with active investment strategies, while maintaining the confidentiality of current portfolio trading information. However, it is important to note that ETMFs are not ETFs. The new investment structure will trade on an exchange, and to achieve their non-transparent nature, the products will trade based on their net asset value, or utilize a so-called NAV-based trading. [New ETMFs Could Eat Away At Mutual Funds’ Market Share]
“ETFs have prospered because, for many people, they are superior to traditional mutual funds,” Cooley said. “Similarly, if implemented skillfully, ETMFs should have significant advantages over currently available actively managed options.”
Due to the ETMF’s structure, active managers can reduce the capital gain hit when selling underlying assets. In a traditional open-end fund, the fund has to sell assets to meet investor redemptions, which can create a realized capital gain for everyone else. Additionally, when a manager rebalances, the action can also create realized gains and generate a tax bill for long-term investors as well.
In contrast, ETMFs utilize ETF’s so-called in-kind swaps to limit the tax hit. The funds undergo a creation and redemption process in which market makers, authorized participants or large institutional investors swap a basket of securities from the underlying benchmark index for fund shares, or vice versa. Consequently, the funds don’t trigger a taxable event. [A Look at the Cogs and Gears Behind ETF Trades]
Unlike traditional ETFs, ETMFs will not disclose holdings on a daily basis. Navigate’s patented methodology allows the funds to trade just once per day at the close of business. However, investors who enter a trade during the day will pay a slight premium to net asset value to acquire shares or receive slightly less than NAV to sell.
Since ETMF transactions occur just once per day, the SEC’s portfolio disclosure requirements will mirror traditional open-end funds, revealing holdings on a quarterly basis.
Along with the potential tax savings, ETMFs could help cut costs in other ways, compared to active mutual funds. For example, traditional open-end funds bear the costs of investors moving in and out of funds, some active funds hold greater cash reserves to meet potential redemptions and many funds charge 12b-1 fees.
Stephen Clarke, the president of Navigate, expects a group of ETMFs from fund providers like Eaton Vance, Gamco Investors, American Beacon and Hartford Financial Services Group to launch late this year or early 2016.
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Max Chen contributed to this article.