It has often been said that exchange traded-funds are "like mutual funds, but trade like equities."
This is kind of true; ETFs are regulated by the 1940 Act for pooled investment vehicles. But as for the "trading like equities" part, it would be better to say that they use the same order types as equities, simply because the effect of share liquidity on price discovery differs significantly between the two.
One trait that is becoming more common between mutual funds and ETFs is the use of active management to execute investment strategies. You may ask why an issuer would want to use a fully transparent investment vehicle to execute an active strategy. The truth is that many of them would rather keep those particular cards as close to their vests as possible. Enter the Semi-Transparent and Non-Transparent ETF, collectively referred to Active Non-Transparent "ANT" ETFs. I wrote an overview of the various approaches a while ago but a recent fund launch prompted me to take a slightly deeper dive into a non-transparent approach provided by solution provider Precidian.
AWEG
The fund in question is issuer Alger Weatherbie's third fund launch, the Alger Weatherbie Enduring Growth ETF (AWEG) . While the fund is actively managed, it is benchmarked to the Russell Midcap Growth Index so portfolio managers will be working in that style box. The fund has a 65-basis point (bps) expense ratio after a 60 bps expense waiver/rebate provided by the issuer through April 30, 2025. With this, a shareholder with $1,000 invested over a calendar year would expect to pay $6.00 over that period.
Reading through the prospectus, the portfolio will be relatively concentrated with the number of holdings topping out at 30. In addition to looking for what they believe to be strong midcap growth plays, the issuer also has contracted with environmental, social, and governance rating firm Sustainalytics to screen out names that score poorly (greater than 25 on the Sustainalytics "ESG" scale).
Regular readers will know that I often like to compare fund holdings to the index methodology or prospectus. This is where things get interesting.
ActiveShares
Issuer Alger Weatherbie has licensed some technology from provider Precidian, which provides the non-transparent exchange-traded fund framework used to manage the fund. Reading through the prospectus to page 20 will bring you to this disclosure: "The Fund makes publicly available its month-end top 5 holdings with a 10-day lag and its month-end full portfolio with a 60-day lag on its website www.alger.com." From this reading, it seems like the Top 5 holdings on March 30 will be made public on April 10 and the full portfolio will be made public on May 30.
In a traditional ETF, the issuer makes the full portfolio available to investors every day and makes an additional portfolio available to capital markets investors. This portfolio also includes any cash needed to exactly replicate the portfolio so that authorized participants can exchange those baskets of securities and cash with the issuer for shares of the fund and vice versa, known as the creation/redemption process. If nobody knows what is in this portfolio, how does the creation/redemption process work? How do market makers keep tight spreads on these products and how do they know what to use to hedge their exposure to the fund?
The short answer here is that they don't, at least not explicitly. The industry uses a kind of index called an Indicative Intraday Value (IIV) sometimes referred to as the Indicative Optimized Portfolio Value (IOPV), which tracks the real-time net asset value (NAV) of a fund less any fees. Per regulation, this must be calculated and disseminated at least once every 15 seconds during the trading day. The ActiveShares technology licensed by Alger Weatherbie uses what it calls a Verified Indicative Intraday Value (VIIV), which is calculated every second.
There is a VIIV methodology document posted on the Alger website and it explains that the verification part of the process comes from the issuer running not one, but two separate calculation engines. What I find interesting is that unlike pretty much every other index ever calculated, the VIIV does not use the last available traded price of the securities in the portfolio. Instead, it derives the midpoint price ("ask" plus "bid")/2 and uses that instead. If for some reason the two values differ by more than 25 bps (0.25%) for more than one minute then trading in ETF shares is halted. Additionally, if over 10% of securities in the portfolio do not have active two-sided markets (both a bid and an ask) then trading in ETF shares is halted.
The fund does have a create/redeem process; it's just that instead of all investors knowing the portfolio, only one does. Anyone who wants to create or redeem shares will provide cash to this special AP who will then trade into the daily basket and exchange those baskets of underlying holdings for shares of the fund and pass them back along the chain.
Wrap It Up
While I understand the desire of portfolio managers to want to protect their intellectual property (IP) I feel that this level of opacity takes things a little too far. Investors simply do not have enough information to make adequately informed decisions. Trading spreads on these products will be wider than traditional ETFs (as disclosed on the issuer's website) and while the VIIV provides a double-checked real-time valuation of the portfolio, it doesn't really give you any idea as to what your invested dollar as doing. As for me, I'm putting this on my watch list probably for some time until there is enough history so I can at least figure out how just how different the portfolio is as compared to the benchmark index.
