Blue Tractor Group (Blue Tractor), a New-York based product developer for the exchange-traded funds industry, has filed an application with the US Securities and Exchange Commission (SEC) to launch a new breed of ETFs.
The Shielded Alpha ETF structure allows for over 90% of the fund’s holdings to remain visible, granting continued insight into the thematic approach of the manager.
The ‘Shielded Alpha’ ETF incorporates a hybrid structure which will maintain the efficiency and reduced costs of a transparent actively managed ETF, while completely shielding the fund’s alpha generation strategy and trading from the market. At no point are the ETF’s precise portfolio holdings known to anyone except for the managers and custodian, preventing reverse engineering of the fund; however, more than 90% of the ETF’s composition will be visible at any one point, allowing greater insight into the thematic approach adopted by the managers.
Terence (Terry) Norman, Founder of Blue Tractor, said in a statement: “We are very pleased to have submitted our application and look forward to working with the SEC over the coming months. It is important to emphasize that a Shielded Alpha ETF is not a non-transparent ETF since with our structure the market will have daily insight into at least 90% of the holdings in the underlying fund portfolio. However, actual holdings and weightings are shielded so that the portfolio is completely unknown, preventing any risk of reverse engineering and related issues such as front running and free riding.”
Simon Goulet, Co-Founder of Blue Tractor, added: “Since early 2015 we have been speaking to market makers, exchanges, issuers and the SEC. These discussions were very helpful to refine the unique attributes of the Shielded Alpha ETF structure and ensure that we address concerns related to pricing, hedging, arbitrage and the ’40 Act. Blue Tractor’s business strategy is to speak with all parties interested in active management and work with select issuers and the SEC to bring this product to market.”
Previous propositions by others to the SEC for a new actively-managed ETF structure have generally included the concept that a third party would disseminate an intraday indicative value (IIV) based upon either a ‘proxy’ portfolio that mimics the abstract statistical risk profile of the unknown underlying portfolio, or actual portfolio holdings if the third party has been granted privileged access to view the underlying constituents. This approach is 100% non-transparent and consequently daily arbitrage, hedging and in-kind creation and redemption in the primary market by authorized participants and market makers will take place, respectively, without any portfolio knowledge.
In contrast, a Shielded Alpha ETF calculates and disseminates the fund’s IIV frequently throughout the day, based upon a dynamic stock specific risk portfolio (Dynamic SSR portfolio). The Dynamic SSR portfolio is not a ‘proxy’ portfolio as it will always have at least 90% overlap with the unknown underlying portfolio, compared to statistical proxies which may have minimal overlap. The Dynamic SSR is able to incorporate the effects of exogenous events throughout the day, allowing for better tracking of portfolio price changes under varying market volatility conditions.
Derivative to the Dynamic SSR portfolio are proprietary algorithms that construct a hedge portfolio (a subset of the Dynamic SSR portfolio), associated in-kind creation and redemption baskets and metrics akin to value at risk (VaR) that signal arbitrage opportunity, thereby providing participants in the primary market with tools to reduce trading risk, adjust ETF inventory and keep the ETF market price close to the underlying portfolio net asset value (NAV) for the benefit of investors in the secondary market.