What do you get when you cross an exchange-traded fund with an actively managed open-end mutual fund? No, this is not a lead-in to a bad finance joke. In fact, it is a genuine third option, called an exchange-traded managed fund, or ETMF, which falls somewhere between ETFs and actively managed open-end mutual funds.
ETMFs are an Eaton Vance (NYSE: EV) creation that they are calling “NextShares.” Like ETFs, these ETMF shares can be bought and sold in real time during the trading day. But like mutual funds, they won’t actually price until after the close at net asset value (NAV). This is called “NAV-based trading.”
Fresh off official Securities and Exchange Commission approval late last year, the new ETMFs are still likely weeks or even months away from being available to the public. But now is a good time to start taking a look at them to see if they fit into your investing needs.
A Closer Look at ETMFs
The basics of the ETMF are simple in their ETF characteristic of intraday trading combined with the open-end mutual fund feature of pricing at the end-of-day NAV. But the innovation, and where it gets a bit more complex, is that you don’t buy or sell shares directly from or to the fund itself, as is the case with mutual funds. This creates efficiency in trading and keeps costs low for both the fund company and the investor.
This ETMF example from Bloomberg View paints a clear picture on how they trade:
“If I want to buy 100 shares, and no one wants to sell any shares, then the market maker will go ahead and get 100 shares from the fund and give them to me. But this too it will do in an interesting way. Instead of delivering my cash to the fund, the market maker will use my cash to buy a basket of assets, and then deliver the assets to the fund in exchange for shares. Like an ETF.”
What this means is that ETMFs won’t have to keep cash available to meet investor redemptions on an ongoing basis the way mutual funds do. This creates an advantage of enhancing returns – assuming prices are generally rising over time – by staying fully invested. The cost savings come from the elimination of trading desks at the fund company to facilitate shareholder trades.
Bottom Line: Should You Buy ETMFs?
Whether or not Eaton Vance’s NextShares are the next big thing remains to be seen. At the moment, it appears as if the best selling point for ETMFs is to investors who want active management with lower expenses than mutual funds.
What is unclear at this point is how investors will embrace the idea of buying shares intraday before they know the closing price. The buyer will pay a premium above the NAV but they won’t know that NAV until 4:00 p.m. I would guess that ETMF buyers would want to trade late in the day to reduce pricing risk.
Who should buy ETMFs? As an investment adviser and money manager, I wouldn’t recommend any form of active management without seeing a track record of performance on the fund or that of the fund manager prior to opening the ETMF.
However, long-term investors wanting active management may benefit from lower costs over time. This still assumes the fund manager does a good job with security selection.
It ultimately returns full circle back to the active vs. passive debate. Most ETFs and mutual funds passively tracking an index will have lower expenses than the actively-managed ETMFs. Therefore, investors who are attracted to the idea of low-cost, passive management will not likely care much for ETMFs.
But ETMFs need not be an either/or decision. There may be some investors who will like the idea of using a passsively-managed index fund or broad market ETF as a core holding and add a few ETMFs as satellite holdings in a diversified portfolio.
No matter how the market embraces them, Eaton Vance’s NextShares are a genuine third alternative in the fund universe for investors to consider. It will be interesting to see if ETMFs can add value to portfolio management.
As of this writing, Kent Thune did not personally hold a position in any of the aforementioned securities. Under no circumstances does this information represent a recommendation to buy or sell securities.
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