ETF providers amend filings to assuage SEC’s concerns

Anxious to launch their next active exchange-traded funds after months of delays, -AdvisorShares Investments LLC, Guggenheim Funds Investment Advisors LLC and Van Eck Global have filed amended documents with the Securities and Exchange Commission to clarify that their products won’t use derivatives.

The SEC said in March that it was reviewing whether additional investor protections were needed pertaining to the use of derivatives by mutual funds, ETFs and other types of investments. Specifically, the SEC said that it would review the ways in which funds use derivatives to leverage returns and whether fund boards were conducting proper oversight of the use of derivatives by funds.

At the time, the SEC said that it wouldn’t provide exemptive relief for any new active ETFs that use derivatives until it has completed an examination of the derivatives question. John Heine, a spokesman for the SEC, said that the commission has no timetable for completing its examination.

Since then, ETF providers have been able to come out with new products, but those that have funds in filing have been stuck in a holding pattern, officials said.

“When the SEC is going to come out with something on this is the $64,000 question,” said Tom Lydon, president of Global Trends Investments, which uses only ETFs in its clients’ portfolios. “A lot of people are frustrated because it’s holding up product development.”

The examination of how ETFs use derivatives was spearheaded by Andrew “Buddy” Donohue, director of the SEC’s Division of Investment Management, who is leaving the commission this week. His departure has some ETF providers wondering if the issue will be put on the back burner at the SEC.

“This does absolutely have an impact on what we would otherwise be doing [in terms of product development],” said William Belden, a managing director at Guggenheim.

The firm filed for exemptive relief on three active-ETF strategies in June 2009: a short-duration fixed-income ETF, a core bond ETF and a commodities-based ETF, the last of which relied largely on derivatives, he said.

But after talking to SEC officials and realizing that the commodities-based ETF and its reliance on derivatives was slowing up the process to get all three ETFs approved, Guggenheim in December amended the filing to separate the fixed-income ETFs from the commodities-based ETF. Then, in April, after the SEC announcement, Guggenheim amended the filing again to clarify that the bond ETFs wouldn’t use options, futures or swaps.

“Derivatives were not a key component of the strategies, but when you go into registration, you typically want to have as wide a band as you can in what you can use if the opportunity presents itself,” Mr. Belden said.

Guggenheim has received the OK to launch the two funds but is waiting for the New York Stock Exchange to procure exemptive relief required to list new active ETFs, he said.

Although derivatives may not be crucial for fixed-income ETFs, they can be helpful tools to hedge against some of the macroeconomic risks and in shorting duration risk, said Scott Burns, an analyst at Morningstar Inc.

“Derivatives come in very handy in fixed income because it can be used for hedging, as well as increasing leverage,” he said.

In May, AdvisorShares amended its filing with the SEC for its High Yield Debt ETF, which it had originally registered to launch last February. The firm has gotten approval and expects to launch the ETF on Dec. 2, said chief executive Noah Hamman.

Not being able to use derivatives shouldn’t have an effect on the strategy, he said.

“Our desire was to get the product out sooner rather than later,” Mr. Hamman said.

Last month, Van Eck amended its filings for its planned Market Vectors Active Africa ETF and its Market Vectors Active Short Municipal ETF, to state that the funds wouldn’t use derivatives.

Adam Phillips, a managing director at Van Eck, said that he expects the amendment to speed up the firm’s ability to launch the funds, but declined to elaborate.

The Market Vectors Active ETF is an example of another product where investors could benefit if it could use derivatives, said Dave Nadig, director of research at IndexUniverse.com.

“One of the challenges with a niche product like Africa is something as simple as equitizing cash,” he said. “By not allowing this fund to use derivatives, it limits their ability to quickly put money to work, which is what many ETFs use derivatives for.”

Overall, investors and advisers should anticipate fewer choices in the active-ETF world until this issue is resolved, experts said.

“There have been very few core active strategies filed in the last six months, and I think you will see that dearth of filings until there is a little bit more clarity around this,” Mr. Nadig said. “But given the SEC’s focus on core market structure issues, I would be stunned if it’s resolved soon.”

E-mail Jessica Toonkel at [email protected].