This podcast focuses on the semi-transparent ETF structure which is apparently alive and kicking despite reports of its demise. Antonette Kleiser, Managing Director, Investor Services, Brown Brothers Harriman and Terry Norman, founder, at Blue Tractor discuss.
The views and opinions expressed are for informational purposes only and do not constitute investment, legal or tax advice and are not intended as an offer to sell, or a solicitation to buy securities, services, or investment products. Views and opinions are current as of the date of the podcast and may be subject to change.
This episode of Off the Record is sponsored by Truss Edge, providers of front, middle and back-office software and services to ETF issuers.
This podcast focuses on the semi-transparent ETF structure which is apparently alive and kicking despite reports of its demise. Antonette Kleiser, Managing Director, Investor Services, Brown Brothers Harriman and Terry Norman, founder, at Blue Tractor discuss.
The views and opinions expressed are for informational purposes only and do not constitute investment, legal or tax advice and are not intended as an offer to sell, or a solicitation to buy securities, services, or investment products. Views and opinions are current as of the date of the podcast and may be subject to change.
This episode of Off the Record is sponsored by Truss Edge, providers of front, middle and back-office software and services to ETF issuers.
Beverly Chandler
Hello, my name is Beverly Chandler and I'm managing editor of ETF Express and I welcome you to the latest edition of Off The Record, the podcast about all things ETF brought to you by ETF Express, in partnership with Truss Edge providers of front, middle and back office software and services to ETF issuers. All views expressed in this podcast are the speakers own and we hope suitably controversial. This podcast focuses on the semi-transparent ETF structure and I'm delighted to be here with Antonette Kleiser, managing Director, Investor Services for Brown Brothers Harriman and Terry Norman, founder at Blue Tractor, a provider of a semi-transparent structure. I'm going to start by asking you both to give yourselves a short introduction, so Antonette, if you'd like to go first, can you tell me a little bit about you, and what you do?
Antonette Kleiser
Yeah good morning Beverly and thank you. And yes, Antonio Kleiser, as you said, I am part of the investor services, the ETF product team at Brown Brothers Harriman. I've been with BBH for more than 12 years working out of their European office in Dublin, but currently since the start of this year, working here in Boston as part of the global ETF product team.
Beverly Chandler
And then Terry, tell us a little bit about you.
Terry Norman
Hi, Beverly, thank you for inviting me. Terry Norman, founder of Blue Tractor and originator of the ideas that underpin the Blue Tractor shielded alpha semi-transparent ETF wrapper. Blue Tractor was formed in 2015 and prior to that I worked at a number of quantitative asset management companies developing alpha strategies and risk models. So Blue Tractor really is a quantitative fintech type company these days. We're one of the six structures that the SEC licenced for the semi-transparent structure in the US.
Beverly Chandler
Brilliant, thanks so much for that. Antonette I'm just going to open by asking if you could give us some context for this whole conversation. When was the semi-transparent ETF structure brought in and where?
Antonette Kleiser
Yes. So back in 2019, the SEC voted to adopt Rule 6C11 and this was around permitting ETFs that met kind of certain criteria to come directly to market without the cost and delay of obtaining exemptive relief. And at the same time, they also approved this exemptive relief for non-transparent or semi-transparent active ETFs for specific providers and the first products were launched I think around 2020. And and and there are two different flavours I suppose if you like, of the the products that were approved. So you had kind of the non-transparent, which is you know one particular active shares Precidian model, and then you have the semi-transparent which for they they approved those for five different, five different providers. And some of those providers are actually licencing those structures so that others may launch sort of ETF's, or or semi-transparent ETF's within that structure.
Terry Norman
Could I, could I just jump in?
Beverly Chandler
Yeah, sure.
Terry Norman
I I will say there's three structures rather than two, and each structure can be defined by its creation unit. As Antonette said, you had the Precidian structure, which sits by itself, which I think most of us realise is non-transparent. Then you have these structures of Fidelity, T. Rowe, NYSE, etcetera, and their creation unit is a mixture of substitute securities and some securities that are in the underlying portfolio that absent the creation unit. So a mismatch. And then you have the Blue Tractor structure which sits by itself and every security that's in the underlying portfolio is in ourcreation basket. There's no emissions, no substitutes. So I would say there's three structures, the non-transparent Precidian the mixture of decoys and substitutes and emissions of the NYSE, fidelity, and then all the names, but different weightings that Blue Tractor offers.
Beverly Chandler
So that would be the way you would differentiate your offering.
Terry Norman
That's the way I I believe it is naturally to differentiate between the structures, by looking at the creation unit.
Beverly Chandler
And tell me, why would an active manager consider using a semi-transparent structure for their ETF?
Terry Norman
There's there's a number of reasons. One, obviously is investor protection, their wealth from predatory traders who in the more illiquid segments of the market will try and front run. And that's to the detriment of the investor himself because it’s his money that's being sort of walked out the door. Then there's the issue of free loading. You know these these managers, they've spent lots of money, resources, developing their investment strategies. And in a fully transparent environment, you're just giving that away to somebody else free of charge. And I don't see the sense in that at all. But I take a view, a lot of these managers who claim to be transparent are really playing with transparency, and that is, if they're really transparent, don't just tell me the portfolio every day. Tell me your target weightings when you're rebalancing. If you've got nothing to fear from predatory traders or anything like that, tell me the weights that you're going to rebalance to. And then as an investor, I can say, well, I'm going to get out of that before he, or she, gets to that position because I don't like it. That's transparency. And in a fully transparent ETF, they don't offer that. So why don't they offer that is the question.
Beverly Chandler
So Antonette, tell give me your view on this in your experience and your why would an active manager consider using a semi-transparent structure?
Antonette Kleiser
Yeah, I'm obviously, I'm not the expert in terms of, but looking at this maybe kind of one step back I suppose. These semi-transparent structures are non-transparent, they're they make ETF's friendlier to the active managers by removing this daily disclosure requirements and for all of the reasons just outlined, you know fears around front running, you know, fears about competitors replicating their strategies. So, so I think these structures allow them to offer more strategies without exposing their methodology. And and you know from the investor’s perspective, they actually all about choice. So in the sense that active managers offering more products gives the investor more choice. So I I think you know they're they're of a benefit to the investor ultimately in the sense that as I said, they're they're they're getting more choice, so. And you know, if you look at this globally, you know this, the the concern around people’s Secret Sauce if you like, you know, would make it more attractive for them in terms of having a semi-transparent or a non-transparent model. You know sort of protecting their IP if you like.
Beverly Chandler
So it's much lauded that investors, ETF investors, love the transparency of ETFs. But do you both think that's changing as ETFs become more focused on active funds?
Terry Norman
I I don't, I don't believe it is. My and my attitude really is, you know, an ETF, one of the key attributes to the ETF success story was transparency. So when you go to, you know, the fully non-transparent, I don't believe investors really want that, to be honest. Obviously you've got the the Blue Tractor structure which gives all the names, which is great because that is full transparency really. The the semi transparent, the ETF structure Blue Tractor offers is actually more transparent than some fully transparent ETFs. So that's that's one case, and I believe a lot of investors, you know, they wanna know that they own Apple. But do they really care that they own 4% or 3.75%? No, they just wanna know the names of what they're exposed to. But, you know, there is a case for, you know, slightly less transparency than what the Blue Tractor structure offers. And that comes sometimes when you're dealing with non-contemporaneous time zones. OK? You're going to have to use models or substitutes, etcetera, if you're going to trade in global markets. So you know, although I'm an advocate of full transparency of the names in an ETF, I recognise when you go global you do need models and substitutes, etcetera. So they have a role in in the ETF space as well.
Beverly Chandler
So do do you agree with that Antonette?
Antonette Kleiser
Yeah. Yeah, no I I agree that was sort of one of the most attractive characteristics of ETF's is their transparency. But as we said, you know these these structures allow active manager or issuers to sort of get over some of the concerns they have. You know, I I think these structures aren't very old, they're only three years old, and they have gathered assets, but they're still a very small percentage, if you like, of the active ETF market, I think it's about 1.6% of the market. So you know, I think there's a lot still to play out, I I think there's different opinions globally on whether there is a need for semi-transparent products. I know that some of the regulators around the world have looked at this and they have concerns around whether the market makers and IP's cannot actually calculate a bid and offer, you know accurately in the absence of full information and and I know each of these different structures provide the information in different ways. And I think there are other considerations from managers when they're assessing the semi-transparent ETFs, around you know licensing, capital markets, portfolio construction. So, yeah, you know, I I I I I think you know as we said, ETFs, the the attractive character is the characteristic is transparency, but there there are other considerations.
Beverly Chandler
And what does.
Terry Norman
Sorry Beverly, I was just going to jump, Antonette makes some really good points there. And you know the key point that I picked up from what Antonette said there was, you know, the size of the semi-transparent ETF market just being 1.6%. It looks like there's, you know, no demand for these structures. But then you've got to recognise the framework within which these structures work in. The regulators in the in the USA prohibit these structures from entertaining any active strategy that uses international equities, any fixed income, any option. So if you're an investment manager in the US and you have options in your strategy, you can't come to us. You have to go fully transparent if you're converting from a mutual fund into an ETF. If you have Japanese equities, any equities that don't trade contemporaneously with the US, we can't entertain you. So if you imagine you know, a football field, we've just been given the corner flag to work within. So it's hardly surprising that the the the size of the strap, the semi-transparent market is so small, because we're not allowed to go and on a level playing field with fully transparent and you know, approach managers who do long short, who include options, who include fixed income, who include international equities. So, let's hope the regulators actually release those handcuffs and then we'll see the true comparison, whether the managers want them.
Beverly Chandler
And is, is there any sign that that's going to happen?
Terry Norman
Not at the moment. You know, Blue Tractor’s filed for, you know, to push the barriers back. And we filed for a long short because at the moment, again, one of the restrictions is we can only have long only strategies. And we're hoping to come to, you know, the end of that either accept or reject. But you know, we're waiting for IM, SEC, to get back to us on that. And then obviously we want to expand the universe to international equities, fixed income options.
Beverly Chandler
And can you tell me what does the offering, because semi-transparent ETF, what does that add to the cost base of an ETF? If it's got a semi-transparent structure built in?
Terry Norman
We we basically charge 4 basis points, but obviously as AUM grows, you know we have break points there. So it's, I like to look at if you've got all your valuable possessions in your home, do you pay a small amount of money for a burglar alarm to protect those assets? Most people do. The same should apply to managers who have individuals’ valuable assets under their control, they should be looking to protect them.
Beverly Chandler
And do you think it adds to the returns?
Terry Norman
Well it, it can. It's particularly in the more liquid segment of the market, if you're being front run. You know there's been a number of papers out, the cost of front running in fully transparent ETF’s with index rebalancing, you're talking you know anywhere from eight, ten, 12 billion dollars a year. OK? There's three papers that have been estimated, have estimated that one by Herb Blank, one by a PhD out of Illinois, and one by Index One. They they've three of them done analysis, and those are the costs that they came up with, so it's a big business, and make no mistake, there's desks in you know most houses that are looking to second guess what what securities are going in, the index coming out. And if they're doing that there and they can see the same on an active fund, why won't they be doing that there as well?
Beverly Chandler
Do you want to comment on that, Antonette?
Antonette Kleiser
Yeah, maybe just a few points, I suppose. You know, there are a number of structures, as we said in terms of in, in this semi-transparent, non-transparent, so in terms of, you know additional cost it probably varies per structure. You know, some you know the appointment of an AP representative in the Precidian active shares model, the additional cost of creating the proxy portfolio daily and the semi-transparent licencing fees to be able to use these, the cost of you know INAV. So there are additional costs over and above those for a standard ETF. So it it may be, and at this point was just made really, that net expense ratios tend tend to be perhaps a little bit higher. In terms of the returns available, you know I I think there's two ways to look at it in the sense that preserving the trading knowledge and protecting it against front running, you know is to the shareholders benefit, but you know, I think it's more about - and we said this before - about choice for investors, and it's and distribution for the issuer. So, you know, I think over the last few years we've seen flows on a global basis sort of out of mutual funds and into ETFs, and active managers are realising they need to have their strategies available in an ETF wrapper. So this may be an attractive way to enter the ETF market when it kind of protects some of the things that they, you know, are concerned about. You know, I I think there's, as I said, there's there's pluses and minuses.
Beverly Chandler
So the, the sort of phenomenon of this year has been this huge growth in active management within ETFs, and do you think that the semi-transparent structure might benefit from that. I'm guessing, Terry, you do, would you see that?
Terry Norman
Well, it it will benefit from it, but the the size of the benefit comes from you know, how much of the space we can play within. We're still, you know, on this postage stamp, and there's all these, you know, we get continual calls from managers. Can you do long, long, short? No. Can you include options? No. So there is no alternate for them. And the interesting thing, and Blue Tractor is the only structure that can offer this, we can offer what we call flexible transparency. So the manager can be fully transparent every day, just like a fully transparent ETF. But when it comes through balancing, he can turn the opacity up to stop the predatory traders. Once he's rebalanced the portfolio, he can turn it down, go fully, essentially transparent again. No other structure can do that.
Beverly Chandler
And then just looking geographically, obviously we've been talking about the US market. Are we going to see semi-transparent structures elsewhere?
Terry Norman
Not in the near term, I don't believe. But you know in in other jurisdictions they are using, you know take Australia for for instance. They use material portfolio information, they they issue a basket, it's not a semi-transparent ETF, but they're not fully transparent, because they issue a basket similar to the, you know, the the models that Fidelity in New York have, where there may be substitutes, etcetera. But I understand that, because obviously you've got non contemporaneous time zones, you're using models. So if it's you, if it's domestic, then you don't need these models. But if you're going to go global, then you do need these more flexible type baskets, so I see growth in Australia, Canada as well, you know have got their own flavour of this. So not all managers want to go 611 fully transparent because it ties their hand. If the if the fund is small to begin with, they may say I've got no issue with this, this is my strategy. Over time if they're successful, and they may wish to adopt the strategy, they're stuck. They can't they can't move from that, they've gotta do full transparency every day. Whereas using Blue Tractor’s flexible transparency, they can be essentially transparent every day if they wish. But if things change, i.e let's hope AUM grows, they might tailor their their investment strategy slightly. They have the option there to go flexible transparency, full transparency, semi transparency. All in one wrapper.
Beverly Chandler
And Antonette, do you feel that this is what your clients want?
Antonette Kleiser
I suppose from BBH's perspective, you know we provide custodian fund administration to ETF issuers globally, so we're we're sort of looking at the ETF issuers side. And and the the question of, the question if you take it up a level, you know around you know these structures globally. So this formal structure doesn't exist exactly as that outside of the US, but transparency is a question sort of globally, particularly, well actually you know in, in a lot of different markets, or dealing with the different in different ways. But if you look at Europe, say for instance, and it differs by exchange and by domicile, what the portfolio disclosure requirements are. So it's not sort of a formal type of ETF, it's more the disclosure requirements. So for instance, like in in Ireland, you're required to disclose your holdings on a daily basis. You know I think in Hong Kong, you know active ETFs and passives have the same portfolio disclosure. So so it it depends on sort of the area of the world as to what the disclosure requirements are. But these official structures, if you like, are you know unique to the US, and in terms of issuers, you know I I think what we've seen is that issuers have become comfortable with the disclosure requirements that are there in the particular markets. You know it, it is raised by issuers, particularly active as they're coming in with regulators in terms of, you know, if there's any leeway around this full sort of daily disclosure. But currently that that is the requirement. And as I said, it differs by market and by by exchange as to what, how often you're required to disclose your, your your holdings.
Beverly Chandler
Thank you so much both of you. Terry, do you want to add anything?
Terry Norman
No, I think I think Antonette summed it up quite nicely there. You know, every jurisdiction has its own requirements at this moment in time, but those those may change, you know. Which jurisdiction wants to be left behind? If you look at Europe for instance, in the US there's semi-transparent. In Canada, Australia, you know they have these, MPI's and other, other methods. The one that's sort of sitting at base camp and only has fully transparent ETF’s, is Europe. And in a way they're being left behind, and that being left behind is restricting investor choice as Antonette succinctly put.
Beverly Chandler
Thank you. I'm going to thank you both, Antonette Kleiser of BBH and Terry Norman of Blue Tractor for your time today. And thank you to you also for listening. This has been an Off The Record podcast from ETF Express, brought to you in partnership with Truss Edge.
Outro
Off The Record is brought to you by ETF Express in partnership with Truss Edge, providers of front, middle and back office software and services to ETF issuers. Production by Imogen Rostron and Lisa Hines and music by Otto Balfour. Thank you to our guests on this episode of Off The Record from ETF Express and to you for listening. We look forward to you joining us next time.