Some market launches of ETFs drum up excitement, others are duds. With Nextshares, the reaction has been wait-and-see.
First approved by securities regulators in 2014, the non-transparent ETP was heralded as a game-changer by its creator, Eaton Vance. NextShares Solutions President Stephen Clarke says actively-traded funds haven't yet overcome industry conservatism.
"One of the reasons that we believe that actively managed ETFs haven't gathered substantial assets is because most established asset managers, or fund companies, have been reluctant to bring their best strategies to the market," he says.
The exchange-traded managed fund, or ETMF concept, was originally developed in the early 2000s by Gary Gastineau and Tod Broms, the innovators behind NAV-based trading, is what "underpins NextShares," Clarke explains.
It has been six years since NextShares Solutions, the Eaton Vance subsidiary licensing NextShares, acquired the patent rights in November 2010. To date, Eaton Vance has registered 18 initial NextShares funds.
While the market is volatile again (In January, ETFs lost $1.8 billion in flows, their first negative net flows since 2014,, according to Cerulli Associates) Clarke says he is confident there is still room for his firm's offering.
"It's protective of confidential portfolio trading information," Clarke tells Money Management Executive, explaining why it can succeed in the increasingly crowded $2 trillion ETF market. "That, we think, solves for challenges that exist both for investors and financial advisors, but also for active managers."
Why unveil the ETMF via your parent company Eaton Vance?
Fundamentally, it took a fund sponsor to be able to apply for the first exemptive relief, so Eaton Vance, in that respect, was the first applicant for exemptive relief to offer what are formally known as ETMFs, which we branded as NextShares. At the core, a fund sponsor was required to be the applicant to lead the effort to bring NextShares through regulatory approval.
We work very closely together with Eaton Vance. While they're also a client, we have a wide number of Eaton Vance professionals working on the NextShares initiative, both from the perspective of bringing NextShares to market under the Eaton Vance banner, but also working with the NextShares team to prepare documentation that we will be sharing with our clients to provide a roadmap for them in terms of how they bring the fund to market.
How does the ETMF work?
ETMFs, which we brand as NextShares, are a new type of actively managed ETP. NextShares are designed to seek the performance advantages and tax-efficiencies of ETFs, while protective confidential portfolio trading information.
So, a key difference between an ETF and a NextShares portfolio is a NextShares portfolio isn't required to disclose its full portfolio holdings to the market on a daily basis like most ETFs are required to do. Because of that, it's a structure that is fully compatible with active management. One of the reasons that we believe that actively managed ETFs haven't gathered substantial assets is because most established asset managers, or fund companies, have been reluctant to bring their best strategies to the market in that structure because it requires daily portfolio holdings disclosure.
With assets dominated by passive, how will NextShares break this trend?
We would suggest that the way to think of this is from the investor's perspective. So if you are an investor and you're invested in an active fund strategy with an established manager with a track record that is delivering value in your portfolio, if that investment strategy could be offered in the structure that would seek to have lower operating costs, better performance and improved tax efficiency, would that be of interest?
It's really appealing to investors and advisors to seek what we believe all investors in active strategies would find appealing and then delivering that in a structure that is compatible with how the active manager runs their business - meaning it's protective of confidential portfolio trading information. That, we think, solves for challenges that exist both for investors and financial advisors, but also for active managers.
What was the SEC approval process like for launching NextShares?
I would describe it as intentionally thorough. The SEC has the responsibility to protect the interests of investors; and in so doing, it was a very comprehensive evaluation and due-diligence process that they performed. The Eaton Vance organization worked over months to provide information to the staff to assist in their evaluation of the concept.
There are really three legs to regulatory approval for an ETP. The first is exemptive relief, and that's something that the fund sponsor files for us - so Eaton Vance filed for that. I think there were four amendments to that application before it was ultimately approved. The second leg of approval is our listing and trading rules - the so-called 19b-4 (Form) - and that's filed by a stock exchange. NASDAQ is our partner stock exchange and they filed the 19b-4 in 2014. Then the third, and final leg, would be registration statements for the funds. Those were filed by the fund's sponsor and they were those registration statements for the first 18 Eaton Vance funds were declared in December 2015.
I would say it's an intensive process that can be time-consuming, but it's quite appropriate and consistent with the protection of the investors' interests.
What types of infrastructure challenges did NextShares face in its launch?
We knew there were going to be infrastructure challenges leading into this, so we elected the NASDAQ as a partner because of its reputation in innovation and for being technologically nimble. NASDAQ committed to building out a centralized trading system to support trading in NextShares. They completed that in September of last year and it has been in testing mode up until when the first NextShares fund was offered. That first fund is being offered publicly by Folio Investing today.
The NASDAQ was the principle place where technology needed to be built, but technological adaptations have been necessary at Folio Investing and will be so at other broker-dealers that elect to offer NextShares. There have been other combinations required around the industry like DTCC, for clearance and settlement, or FINRA for trade reporting, at market-maker to support the providing of liquidity for NextShares. All of this has been through testing up until its (launch).
I am very pleased to say that initially the first fund has been operationally successful and the trading has occurred in the way that one would have expected it to occur.
Have there been any difficulties regarding the licensing with this product?
Our business is one of licensing intellectual property. We're licensing patents and other intellectual property like trademarks that would be helpful to a company coming into this space. We also assist companies under a standard fee arrangement, so this licensing is one where we are charging a single-digit basis point fee to the fund, based on AUM. So, there's no front end cost for a company to get into this business, in terms of there being no front end licensing fee. The funds themselves will pay a fee to NextShares solutions based on assets once they're up and running, and successful.
There are a dozen companies at this point, including Eaton Vance, that have entered into preliminary agreements with NextShares and have filed for and received exemptive relief - so permission to offer NextShares, and we expect that that list will grow. We are in talks with numerous fund companies currently - some large to mid-sized firms - that have expressed interest in offering NextShares.
But what is mainly the next milestone that will be important in all of this will be expansion of distribution. So, NextShares are currently offered today at Folio Investing and Folio Institutional, but we are in talks with other broker dealers about expanding that universe of broker dealers where NextShares could be offered. We've had companies tell us that as they see distribution materialize, they will be interested in the NextShares consortium. So, we are anticipating seeing more broker-dealers coming on in 2016 and more asset managers joining the effort to bring NextShares to market.
Why should managers get into the NextShares business, and what kind of costs would be required?
I think we have very solid firsthand knowledge of this currently after working with Eaton Vance to see the first fund list in trade.
Without putting a hard number on it, the cost for doing this is very similar to the cost a fund sponsor would incur in getting into the ETF business because there are a tremendous number of commonalities between offering NextShares and offering an ETF. The principle difference is, in an ETF, when you expose a basket to the market every day; it needs to be a pro rata slice of your fund holdings. When a NextShares portfolio exposes its basket to the market there is no such requirement, so determinations need to be made about what to include in the basket.
I would say part of our role at NextShares is working with Eaton Vance and then working with all the other fund sponsors to ensure that the basket operation process, and every other aspect of this, would be implemented in a way that is efficient, minimizes costs and makes sense for their business. So, that's an important part of the service that we provide to our clients; to be in a position to assist them in that process.
Where do you anticipate seeing NextShares this time next year?
If we are as successful as we plan to be, we will see a broad range of broker-dealers and fund companies offering their best investment strategies in the NextShares structure.
One important piece of this is because NextShares are compatible with all asset classes, a fund company can offer any of their existing strategies in this structure without limitations. So, as Eaton Vance says it plans to introduce an income fund and a global fund later in the month of March, and looking out a year, we would expect to see a broad range of funds at Eaton Vance and other asset managers offered by a broad range of broker dealers.
There are some 80 funds that have been referenced in exemptive relief filings by the dozen companies that are members of the NextShares consortium, and we anticipate some of those firms will begin filing registration statements for their own funds in the coming weeks to months.