On July 7th, 2010, Legg Mason filed an amended 40-APP document with the SEC with the noticeable difference being the exclusion of derivative usage within the proposed “Initial Fund”. The 40-APP filing is one of the first steps in achieving exemptive relief from the SEC for actively-managed ETFs.
Legg Mason had filed the original documents in late February, which indicated plans for a fund that “may use a wide variety of exchange-traded and over-the-counter derivatives, including options, futures and swap contracts, and forward foreign currency contracts”. The removal of that clause is clearly motivated by the SEC’s ongoing investigation into the use of derivatives in ETFs – primarily leveraged, inverse as well as actively-managed ETFs. The SEC’s investigation which was announced in March, has effectively placed nearly all new Active ETF launches on hold, as evidenced by just one new actively-managed being launched on the US market since February.
This move follows similar ones by other players in the space such as AdvisorShares which made a similar amendment to its Peritus High Yield ETF filing back in May, in an effort to speed up the approval process. When the SEC will complete its investigation remains unclear, but until then, issuers will continue to try as hard as possible to avoid coming under the SEC’s microscope. In the larger scheme of things, actively-managed ETFs shouldn’t be coming under too much pressure from the investigation because most proposed and existing Active ETFs on the market utilize derivatives primarily for hedging and risk management purposes. This is unlike leveraged and inverse ETFs where the use of derivatives is a key component to the implementation of their investment mandates.
Legg Mason’s original filing came at a time when other major mutual players such as Eaton Vance were also expressing interest in participating in the actively-managed ETF space. Their “initial fund” is intended to invest in equities of US and non-US companies as well as ADRs. The advisors will likely follow a quantitative model in the security selection process, utilizing factors such as low valuation, return on capital, competitive advantages and market action. The fund may even utilize several different managers.
Disclosure: No positions in above-mentioned names.
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