The U.S. Securities and Exchange Commission is partially lifting an almost three-year-old moratorium on applications for actively managed, exchange-traded funds, creating an opportunity for fund managers to use derivatives when they launch them.
Exchange-traded funds, or ETFs, are similar to mutual funds, but trade on exchanges on a real-time basis.
Only 37 of 1,267 ETFs in the United States are actively managed, according to Lipper, a subsidiary of Thomson Reuters Corp.. They represent 0.93 percent of the $1.2 trillion in assets in U.S. ETFs.
In March 2010, when the SEC began reviewing the risks posed by how mutual funds and ETFs used derivatives, the commission placed a moratorium on all applications from firms looking to open ETFs that used such instruments, including credit default swaps.
On Thursday, the director of the SEC's investment management division, Norm Champ, told a conference hosted by The American Law Institute Continuing Legal Education Group in New York that the moratorium, for the most part, would be lifted.
Now, after almost three years the agency is lifting the moratorium for the most part, Norm Champ, director of the investment management division, said in New York on Thursday at a conference hosted by The American Law Institute Continuing Legal Education Group.
With the moratorium's end, mutual funds will have an easier time getting into the actively managed ETF space and both will have more flexibility when it comes to using derivatives, experts said.
"This will mean more choice and more options for the end investor," said Tom Lydon, president of Global Trend Investments, a registered investment adviser and editor of ETFTrends.com.
MORE FLEXIBILITY FOR FUNDS
Champ, in his speech, clarified that the agency will consider applications for actively managed ETFs that use derivatives under two conditions: the funds' boards periodically review and approve their use; and the funds disclose the use of derivatives periodically consistent with SEC guidance.
The agency, however, is still not considering applications for leveraged ETFs, Champ said.
Over the years, with no end to the SEC's moratorium in sight, fund companies and ETF providers began applying to start actively managed ETFs without using derivatives.
But being able to use derivatives offers managers more flexibility in gaining returns, said Adam Patti, chief executive of Rye Brook, New York-based IndexIQ, an ETF provider with $940 million in its passively-managed ETFs.
IndexIQ did receive an exemption to launch active ETFs without using derivatives earlier this year, but now may apply to launch active ETFs that use derivatives, Patti said.
"This is very big news and this is definitely something we would want to have," he said.
Pimco, which as of June had $1.82 trillion in assets under management, launched the Pimco Total Return ETF in January. It was seen as a cheaper, more transparent way for mainstream investors to access bond guru Bill Gross.
The ETF now has $3.8 billion in assets and is essentially, a clone of Gross' $252 billion Total Return mutual fund, except it cannot use derivatives.
But the moratorium's partial end may change that.
"This means that firms like Pimco can now better implement their strategies," said Dave Nadig, director of research at IndexUniverse LLC, a San Francisco-based ETF researcher. "BOND, for instance, doesn't hold the credit default swaps that are a staple of its mutual fund brother.
"With this news, Pimco could file for extended relief to let them more closely mirror the portfolio," Nadig said.
A Pimco spokesman did not return requests for comments.
While the SEC's decision to lift the moratorium on active ETF applications may make it easier for mutual fund companies to enter the sector, many experts are skeptical if they will do so.
For one thing, with active ETFS portfolio managers would have to agree to have all of their positions made available to the public on a daily basis.
"Most traditional active ETF managers are terrified of that idea," Nadig said.
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