Opacity is as opacity does, so should it ultimately matter whether or not the opacity of an ETF’s underlying instruments applies to security selection or the underlying asset itself?
When Jacob Fields started experiencing chronic pain in his lower back, the sixty-year-old former dock worker at the Port of Boston was reluctant to start himself on a course of painkillers.
A staunch evangelical, Fields had heard more than one story of fellow colleagues who, like him, suffered from chronic pain, were prescribed a course of painkillers such as opioid-heavy OxyContin and eventually became addicted, moving on to harder stuff like heroin and fentanyl.
Instead, Fields went in search of other, more holistic remedies, which led him ultimately to Boston’s Chinatown, where tucked behind the rows of dim sum and roast duck restaurants lay a particularly unassuming apothecary doling out lotions and potions from the Far East.
Although Fields was a skeptic, a close friend who suffered from similar ailments swore by the Chinese physician’s healing balm.
“But what’s inside it?” Fields had asked of his friend repeatedly.
“Why does it matter what’s inside it? You’re not eating it, right? You’re applying to your body and so far it’s worked hasn’t it?” came the nonplussed response.
And as it turned out, the Chinese physician’s healing balm contained nothing more sinister than some lily bulb, sweet wormwood and willow bark — hardly the stuff of nightmares — but as any self-respecting Chinese physician will attest, the magic is in the make-up of each ointment, balm or cream and it was with the skilled hand of an expert that the combination of natural ingredients lead to the creation of the comfort-inducing elixir.
A New Dawn For ETFs
Which is why when asset manager American Century Investments received regulatory approval to bring so-called “non-transparent” exchange-traded funds (ETFs) to the market under a framework licensed from Legg Mason affiliate Precidian Investments, a slew of other asset managers noted the approval with eager anticipation.
Because Precidian’s ActiveShares design allows managers to avoid disclosing their complete portfolio holdings on a daily basis, it allows far more leeway for active managers who generally prefer to avoid publicly disclosing their investment strategies — or their secret sauce.
Speaking with the Financial Times, head of ETFs at American Century Ed Rosenberg disclosed,
“The overall structure itself allows us to bring forth products that we normally couldn’t.”
Because asset managers have long been concerned about being front run by competitors, most have avoided dabbling in ETFs, instead offering actively managed products in the form of mutual funds which only require portfolio holdings to be disclosed quarterly, instead of daily — a result of which means that ETFs generally do not absorb active managers’ best ideas.
And while the current ETF design only applies to U.S. securities such as stocks, real estate investment trusts, futures and treasuries, licensees of the Precidian Investments’ model could in time expand that framework to also include other assets as well.
As the new “non-transparent” ETF framework is expanded, a case could eventually be made that it should also apply to otherwise inaccessible assets such as cryptocurrencies as well.
Keeping Your Cards Close
Demand for the “non-transparent” framework has been overwhelming with Precidian Investments having already signed licensing agreements for the ETF structure with 12 investment companies managing at least US$14 trillion with a further two dozen firms also declaring their interest in the structure.
Precidian Investments CEO Dan McCabe notes,
“To the average customer, it is going to look, settle, trade and clear like every other exchange traded product.”
The move to approve “non-transparent” ETFs has the potential for active cryptocurrency managers to make a case for the structure to be extended to also include cryptocurrencies.
Given that Bakkt, which is backed by the Intercontinental Exchange, owner of the New York Stock Exchange, has already received approval from the SEC to custody cryptocurrencies such as Bitcoin, it would be entirely plausible to create a fully-regulated Bitcoin or cryptocurrency ETF product, with the assets being custodied by Bakkt’s warehouse.
Melding that institutional-grade custody service with a “non-transparent” ETF structure would allow institutional investors who till now have had to deal with relatively opaque cryptocurrency hedge funds charging high fees, an opportunity to participate in the nascent sector.
To be sure, the idea of a cryptocurrency ETF or a Bitcoin ETF is not new.
Firms have been lobbying the SEC unsuccessfully for some time now to have their cryptocurrency ETFs approved.
But that may be changing.
Change Is In The Air
Just last month, a new fund from investment giant VanEck and fintech player SolidX Management provided big-money buyers a way to invest in Bitcoin.
The exclusive over-the-counter product, which began trading in late September on an alternative trading system regulated by the SEC, shares similarities with ETFs, but is not strictly speaking an ETF because it is not traded on a national exchange.
Named the VanEck SolidX Bitcoin Trust 144A Shares and available only to “qualified institutional buyers,” Jan Van Eck, CEO of Van Eck Associates and president and CEO of the VanEck Vectors ETF Trust, speaking to CNBC, notes that the product is a way to get institutional clients into the cryptocurrency space,
“We’re not directly or indirectly trying to sell to retail (investors). That’s not what this game is.”
“Any individual, no matter how rich, can’t buy it. It has to be an institution. It has to be a corporation (or) a bank, but a hedge fund can buy it, a mutual fund can buy it, and an ETF can buy it.”
“So even a US$20 million ETF could buy this fund and get some Bitcoin exposure.”
And with the launch of “non-transparent” ETFs now all the rage, it is entirely plausible for these “non-transparent” ETFs to make a play for VanEck and SolidX’s Bitcoin product.
The ingredients to precipitate this evolution for the entry of institutional money into the cryptosphere is already present.
ETF consultant and former head of ETF sales at Deutsche Bank, Chris Hempstead notes,
“We’ve had this kind of thing happen in the ETF world over and over again for the last 25 years. What you have here is a new idea that’s making progress towards something that people are very familiar with.”
Not so long ago, ETFs were considered exotic instruments until they entered the mainstream investment consciousness, as is happening now for “non-transparent” ETFs and now with VanEck and SolidX’s Bitcoin product.
The ascent of “non-transparent” ETFs could not have come at a more opportune time for cryptocurrency proponents.
Although money mangers have shifted client portfolios to ETFs to reduce costs, ETFs have offered little options for active management, until now.
And while actively managed ETFs are likely to be more expensive than index ETFs, they will still be cheaper than the actively managed cryptocurrency options currently available, such as hedge funds and the like.
What this means is that there is a credible opportunity for firms such as VanEck and SolidX to literally make hay while the sun shines and weave the best elements of “non-transparent” ETFs with the newly available institutional-grade options for custodying cryptocurrencies to allow for meaningful participation in cryptocurrency investment at a cost lower than cryptocurrency hedge funds.
Despite the slew of SEC rejections of proposed ETFs, with objections ranging from scalability to stability, volatility to manipulation, the SEC has left the door ajar for the possibility that cryptocurrency ETFs could yet be approved at some point in the future.
As far back as March 2018 (a lifetime in the cryptoverse), the SEC considered rule changes to allow for Bitcoin ETFs.
And while those considerations ultimately led nowhere, the musings were also well before Bakkt’s physically-deliverable Bitcoin futures contracts came onto the stage and before Bakkt and Coinbase were awarded trust company status, allowing them to custody cryptocurrencies such as Bitcoin.
For now, at least, it is unlikely that retail investors will gain direct access to a Bitcoin ETF, but then that may not be the point, to begin with, because retail investors have long had direct access through both regulated and unregulated cryptocurrency exchanges to Bitcoin itself.
What has been lacking though is access to cryptocurrencies without the necessary baggage of managing private keys or having the tech-savvy to jump through the numerous hoops required to hop onto the cryptocurrency bandwagon.
ETFs are different in the sense that the ETF itself must hold the underlying assets and manage those assets safely for the benefit of holders of the ETF.
So despite increased friction and administrative costs, a cryptocurrency ETF makes it possible for both institutional and retail investors to partake in the nascent digital assets.
Throw in the advent of “non-transparent” ETFs and it’s not a stretch of the imagination to consider where the space is headed.