On November 6, 2014, the Securities and Exchange Commission (“SEC”) issued notice of its intent to grant Eaton Vance Management (“Eaton Vance”) and related parties exemptive relief from various provisions of the Investment Company Act of 1940, as amended, to permit the offering of a new kind of registered open-end investment company – so-called “exchange-traded managed funds” or ETMFs.1 As described in more detail below, ETMFs are a hybrid between traditional mutual funds and exchange-traded funds (“ETFs”) in that, like mutual funds, they would not provide daily portfolio transparency, while featuring, like ETFs, secondary market trading, except that ETMF shares would trade on an exchange at prices based on net asset value (“NAV”) plus a premium/discount determined during the trading day. Interested persons may request a hearing on the matter by contacting the SEC on or before December 1, 2014. The SEC announced that an order granting the requested relief (“Order”) will be issued unless the SEC orders a hearing.
The Order would apply to 18 initial ETMFs for which Eaton Vance filed registration statements, and future funds managed by Eaton Vance and its affiliates that comply with the terms and conditions of the Order. Aspects of the operation of ETMFs are protected intellectual property held by an Eaton Vance affiliate, which intends to enter into license and services agreements with Eaton Vance and other registered investment advisers (“Licensed Advisers”) to permit the offering of ETMFs. The Order will provide that Licensed Advisers may file requests for exemptive relief that incorporate by reference the terms and conditions of the Order.
On November 7, 2014, the SEC separately approved a rule proposal submitted by NASDAQ Stock Market LLC (“Nasdaq”) that will govern the exchange-listing and trading of ETMFs (the “19b-4 Order”).2 Importantly, Nasdaq did not propose to list any ETMFs pursuant to the 19b-4 Order, which specifically provides that Nasdaq will seek SEC approval of ETMF-specific rule proposals before the listing of an ETMF. In addition to approving ETMF-specific exchange-listing rules, the SEC must also declare effective the registration statements of individual ETMFs before such ETMFs may commence operations.
A Hybrid Between Traditional Mutual Funds and ETFs
ETMFs combine features of both traditional mutual funds and ETFs. Like ETFs, ETMFs will be exchange-traded, directly issue and redeem shares only in creation units (although ETMF creation units may consist of as few as 5,000 shares), impose fees on creation units issued and redeemed to authorized participants to offset related transaction costs, and primarily utilize in-kind transfers of portfolio holdings in issuing and redeeming creation units. Like mutual funds, ETMFs will be bought and sold at prices linked to end-of-day NAV and will seek to maintain the confidentiality of their current portfolio by disclosing holdings only quarterly at a 60-day lag. ETMFs are structured in this manner to provide certain cost and tax efficiencies of ETFs to investors, while maintaining the confidentiality of current portfolio positions similar to mutual funds.
Exchange Trading and NAV-Based Pricing
ETMF shares will be listed and traded on national securities exchanges throughout the trading day at prices based on the ETMF’s next-computed NAV plus or minus a premium/discount that may vary during the trading day. This premium/discount would be quoted by market makers in ETMF shares. There would be no fixed relationship between market prices and NAV, which means for each trade, the premium/discount would be locked in at trade execution and the final transaction price would be determined at the end of the business day when the ETMF’s NAV is calculated. Accordingly, unlike ETFs, such “NAV-based trading” would not offer investors the opportunity to transact at prices based on current (as opposed to end-of-day) determinations of the shares’ market value. Instead, like intra-day orders to buy or sell mutual fund shares, an ETMF investor would not know the NAV at the time the order is placed, but the levels of premium/discount would be fully transparent allowing investors to see the execution costs of buying or selling shares.
Creation Units and Intra-day Indicative Values
Like ETFs, ETMF shares may only be purchased and redeemed directly with the ETMF by or through authorized participants in creation unit quantities, principally in exchange for instruments specified by the ETMF at the beginning of each business day (the “Basket”). Basket instruments may include cash, securities and/or other transferable instruments, although the Applicants represented that purchases and redemptions would primarily occur on an in-kind basis. In order to protect the confidentiality of the ETMF’s current portfolio, an ETMF’s daily Basket will normally vary from the composition of its portfolio. The Applicants represented that the names and quantities of the instruments that constitute the Basket on a given day would be identical for all purchasers and redeemers of creation units that day, except in certain limited circumstances.
To preserve confidentiality of an ETMF’s trading activities, the Basket would normally not be a pro rata slice of the ETMF’s portfolio. Instruments being acquired by the ETMF will generally not be represented in the Basket until their purchase is completed, and instruments being sold may not be removed from the Basket until the sale is substantially completed. Other portfolio positions may be excluded from the Basket if the ETMF’s adviser deems it in the best interests of the ETMF and its shareholders. The Basket may include proportionately more cash than in the ETMF’s portfolio, with such additional cash substituting for portfolio positions that are not included in the Basket.
Like ETFs, ETMFs will cause intra-day indicative values (“IIVs”) to be publicly disseminated at periodic intervals throughout the regular trading session of the listing exchange each business day. ETMF IIVs will be disseminated at intervals of not more than 15 minutes, rather than at the 15-second intervals at which ETF IIVs are normally disseminated. IIVs play a different role for ETMFs than in conventional ETF trading. In the context of ETMFs, the sole purpose of IIVs is to help investors determine the number of shares to buy or sell if they want to transact in an approximate dollar amount (i.e., if I want to acquire approximately $5,000 of an ETMF, how many shares do I buy?).
The SEC actions with respect to ETMFs open new opportunities for the development of non-transparent actively-managed ETF structures. Please contact us if you would like more information regarding ETMFs or other non-transparent actively-managed ETF structures, or to discuss how you can utilize such structures or otherwise consider the implications of the SEC actions.