Examining a Benefit of Active Non-Transparent ETFs | ETF Trends

With more active non-transparent ETFs (ANTs) bursting onto the scene, advisors may want to examine one of the important perks of this fund structure: warding off front running.

A base definition of front running implies some level misdeed as it says the action is a trade based on non-public information. In the fund world, front running is more about traders speculating that a fund manager or index fund provider is about to add or jettison certain securities. The front runner makes the move before the manager or fund company, potentially having adverse effects on other investors.

ANTs can ameliorate that scenario.

Reducing the risk of front running benefits shareholders by supporting an asset manager’s flexibility in managing trading costs and time frames,” according to Fidelity, which currently issues three ANTs and is licensing its structure to other companies.

Fighting off Front Running

ANTs alleviate concerns about daily portfolio disclosure, meaning the funds don’t share portfolios positions on a daily basis as is the case with most traditional ETFs. However, ANTs have daily liquidity that ETFs are known for, something traditional active mutual funds lack.

By not disclosing information about the ETF on a day-to-day basis, this active ETF may face less risk that other traders can predict or copy its investment strategy in what is typically called “front running”. Consequently, by allowing the money manager to maintain his or her secret sauce, this may improve the ETF’s performance.

Unlike other actively managed ETFs, Fidelity’s active non-transparent ETF publishes each business day on its website a “Tracking Basket,” which is designed to closely track the daily performance of the fund but is not the fund’s actual portfolio. Fidelity has argued that this daily published tracking basket provides enough information to facilitate market maker participation and hedging of intra-day arbitrage among market makers or Authorized Participants.

“Reducing the odds of fnt-running reduces the odds that a security being bought by a fund would be bid up in price, which would potentially decrease the return of that strategy, according to Fidelity,” reports ThinkAdvisor. “Less front-running also gives portfolio managers the time they need to manage cash flows and shift capital out of existing holdings into new ones in order to maximize alpha, which also benefits investors, according to the Fidelity report.”

For more on active strategies, visit our Active ETFs Channel.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.