Goldman files for ETF that will keep holdings secret

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By:
Mark Baker
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In applying for exemption to the requirement to disclose an ETF’s portfolio, Goldman Sachs joins a small group of firms testing a new approach.

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Goldman Sachs has filed for a new exchange-traded fund (ETF) that it is asking the SEC to exempt from the usual requirement to publish a daily breakdown of its underlying holdings.

In doing so, it becomes the latest of a small band of issuers to have sought the exemption, which was first granted to Precidian Investments in April when it created the ActiveShares ETF model that Goldman will use.

It also adds to the push of the ETF sector into areas of active management, a trend that might help mitigate signs in 2019 that passive investment fatigue might be setting in.

In its marketing materials, Goldman will tell investors that “this ETF is different from traditional ETFs”.

Typically, the SEC requires disclosure of an ETF’s portfolio every day to facilitate the arbitrage mechanism that enables ETF shares to trade close to the net asset value (NAV) of the underlying holdings.

However, Goldman noted that the SEC had recently allowed other actively managed ETFs, such as Precidian, to avoid such disclosures and instead find other ways of enabling the arbitrage process to take place.

Verified intraday indicative value

The new ETF will use a similar mechanism to that at Precidian, with the funds calculating a verified intraday indicative value (VIIV), which will be disclosed every second of a trading day. Traditional ETFs publish an indicative intraday value every 15 seconds.

The existence of the VIIV, Goldman argues, will enable retail investors to make an informed decision on whether to buy or sell. It will also allow arbitrageurs to take advantage of any premium or discount in the market price of the ETF shares, thus creating the conditions whereby the shares can trade close to the NAV of the underlying fund.

Under the ActiveShares method, the creation and redemption of ETF shares – which is the process by which primary liquidity is achieved in an ETF, as distinct to secondary liquidity, via the secondary trading of ETF shares – is carried out via a confidential brokerage account at a broker-dealer on behalf of an authorized participant (AP) for the ETF.

APs are market participants authorized to carry out the creation and redemption process of shares for a specific ETF.

Before the market opens each day, each of the broker-dealers will be given details of the creation basket, which contains the details of the ETF’s underlying securities. This allows them to act on any instructions from APs to create or redeem ETF shares by buying or selling positions in those securities, but without the APs having access to the information about the basket.

At its heart, the structure is intended to protect a fund manager’s ability to use its own investment strategies without fear of those strategies being easily copied by rivals. It would therefore, Goldman argues, give retail investors access to strategies that would not be available within traditional ETF structures – and in a more efficient and cheaper way than through mutual funds.

The same arguments were made previously by Precidian and other firms to have adopted the technique.


Bid/ask quotations are updated much more frequently than last sale prices, meaning that the VIIV should be more accurate 

ETF shares will be subject to splits and reverse splits to keep the shares within a pre-defined range, as with previous similar applications. The approach is another way in which the technique seeks to maintain the confidentiality of the portfolio.

By restricting the ETF shares to a tight price range, the transmission of volatility in the underlying shares to the ETF shares is dampened, making it a much less effective clue as to the composition of the portfolio.

Additionally, the broker-dealer conducting the underlying share purchases or sales to effect creation and redemption instructions by APs will do so by breaking those transactions up into smaller trades.

The VIIV will be calculated using two engines that will be monitored in real time by a pricing verification agent. If the values from the two engines differ by more than 25 basis points for 60 seconds, the exchange where the ETF shares are listed will be asked to suspend trading until the two align again.

The price used to determine the value of an underlying holding will be the mid-point between its best bid and best ask. The method ought to allow investors to compare the VIIV with the market price of the ETF shares.

In its SEC filing, Goldman noted that Precidian had considered using the last sale price of a security to determine the VIIV, but decided that the speed of newsflow meant that the last sale price might not be an accurate representation of where traders might be willing to buy or sell.

Bid/ask quotations are updated much more frequently than last sale prices, meaning that the VIIV should be more accurate.

Risk

However, it also raises a risk. The bid/ask spread on a particular underlying security might be big, meaning that the mid-point will be less meaningful as an indicator of where a trader would transact. If Goldman determines that this is the case, the identity and weighting in the VIIV of that security will be published.

The theory is that this will allow investors to work out their own valuation of that security, and therefore allow them to assess the accuracy of the VIIV.

Additionally, if at any time 10% of the fund’s portfolio of underlying shares is either suspended from trading or is assessed to not have “readily available market quotations”, suspension of trading in ETF shares would be sought.

Circuit breakers at stock exchanges, while seeking to protect investors, have in the past had the effect of disrupting the integrity of ETFs and this measure seeks to mitigate that. Goldman notes that this is not something that is commonly available in traditional ETFs.

If within the first three years of the ETF operating there is a period of 30 days per quarter or 15 consecutive days in which the ETF closing price or its bid/ask deviates from its NAV by 1%, or in which the bid/ask exceeds 1%, the advisory board of the ETF will meet to discuss its viability or possible remedies.