Exchange-traded funds thrive on assets, liquidity and transparency, but recent ETF filings and launches are challenging conventional wisdom on how these three aspects come together.
With ETFs having recently passed $10 trillion in assets under management in the U.S., product issuers are constantly looking for ways to shoehorn different assets and exposures into the specific constraints of an ETF. Particularly important for intraday trading, the market needs adequate information to price the ETF throughout the day and confidence that the underlying assets can be readily bought or sold.
Recent regulatory shifts have also played a role in defining the realm of ETF possibilities.
For example, the modernization of ETF rules in 2019 brought about the launch of countless actively managed ETFs and leveled the playing field for issuers. Asset managers and investment advisers had previously relied on separate and unique relief from constraints of the Investment Company Act of 1940. Issuers have also been emboldened by the early 2024 launch success of spot bitcoin ETFs, despite their decade-long push for approval by the U.S. Securities and Exchange Commission. These products now collectively hold roughly $60 billion in assets.
Bring your own assets
An under-the-radar but established trend among ETFs has been the seeding of new products with assets from institutional investors, asset managers or separately managed accounts. These transitions are often done to ease portfolio-level liquidity for the end investor while maintaining the exposure.
One such option in the U.S. is known as a 351 exchange, whereby assets from a diversified portfolio are contributed to an ETF in exchange for ETF shares that inherit the tax basis of the original positions. This is the method currently fueling mutual fund to ETF conversions.
Now, Cambria Investment Management, working with white-label firm Alpha Architect, is planning to launch three ETFs that would open such exchanges to any contributed portfolio that meets regulatory diversification standards.
The approval and launch of these products would set a new bar for ETF seeding, which was traditionally done with cash or the specific assets needed to create the exposure. The planned ETFs would liquidate the contributed assets as appropriate in shifting to their indicated exposures. According to Alpha Architect, the exchange is tax neutral for investors — i.e. the resulting ETF shares inherit the cost basis and tax lots of the contributed securities — while adjusting the exposure.
“This type of funding is another example of how ETFs continue to democratize investing,” said Meb Faber, chief investment officer at Cambria. “We’re opening up a transaction that was previously only available to accredited investors through an exchange fund.”
Get liquid
Another recent product is challenging the notion that ETFs can’t fit within Rule 2a-7 of the Investment Company Act, which defines money market mutual funds.
The $40 million Texas Capital Government Money Market ETF, launched in late September at a 0.20% expense ratio, is the first ETF that complies with 2a-7 portfolio construction and liquidity requirements.
“This offering is part of building a full-service firm here in Texas,” said Daniel Hoverman, managing director and head of corporate and investment banking at Texas Capital. “Clients can gain exposure to a money market at a reasonable fee.”
Unlike most money market mutual funds, however, the ETF does not maintain a $1 net asset value per share. Priced initially at $100 per share, the ETF value tends to increase daily based on interest accruals. It will primarily hold overnight repurchase agreements, as well as Treasury bills and notes and agency debt when available.
Over the years, fixed-income ETFs have inched closer and closer to the $6.3 trillion world of money market funds without crossing over. Ultrashort fixed-income ETFs have become a favorite near-cash vehicle for a variety of investors, but do not earn the accounting treatment as “cash or cash equivalent,” and were often not permitted by policy to be owned in corporate treasury or used in collateral management for securities finance.
The entry of ETFs into the 2a-7 world may have both corporations and institutional investors rethinking how they manage cash.
Stay private
The proposed SPDR SSGA Apollo IG Public & Private Credit ETF from State Street Global Advisors is likely the most controversial of recent filings to challenge notions of ETF liquidity.
While primarily holding investment-grade fixed-income securities, the ETF will also seek to invest no more than 15% of its assets into private credit investments sourced by Apollo Global Securities, according to the prospectus. These could include investments in private funds, interval funds, or business development companies, with Apollo itself providing intraday liquidity to the private credit sleeve. Moreover, the fund may invest up to 20% of its assets in high-yield securities.
“This is uncharted territory for ETFs, and for good reason. There's an inherent contradiction between how the private markets operate and the ETF model,” said Kirsten Chang, senior industry analyst at research firm VettaFi. Chang questions how a fair price would be determined for the private credit exposure.
The SSGA filing was followed by filings from BondBloxx Investment Management and Virtus Investment Partners looking to offer ETFs investing in private collateralized debt obligations, following on the asset-raising success of the $13 billion Janus Henderson AAA CLO ETF, which invests in registered CLOs.
Such barrier-breaking ETF filings seek to dispel the narrative that ETF innovation is slowing. The move into both highly liquid and less liquid investments, as well as novel ways to seed products, could spur a new wave of ETF proposals. In the crosshairs: private equity and venture capital investments, which occasionally make their way into mutual funds, but remain elusive for ETFs.
