The Shielded Alpha℠ ETF Wrapper - the '101'
1. ETF Portfolio
The Shielded Alpha℠
is simply a 'wrapper' that facilitates active portfolio management within an exchange-traded fund (ETF) structure. An ETF provides considerable advantages over a traditional mutual fund structure, including lower costs and greater tax efficiency. But as importantly, because of its novel creation basket structure the Shielded Alpha℠ ETF wrapper fully obfuscates an active portfolio manager's alpha generation strategy and trade execution from predators.
Run your actively managed ETF portfolio no differently than a traditional mutual fund or SMA - no changes to portfolio management are required. Manage the portfolio directly or use sub-advisers for some or all of the portfolio.
The investable universe for the Shielded Alpha℠ ETF wrapper consists of domestic large, mid and small-cap equity securities, other ETFs, futures, American Depositary Receipts (ADRs) and foreign equity securities from markets that trade contemporaneously with the U.S.
Short strategies and fixed income instruments currently are not permitted under Blue Tractor's SEC exemptive relief application.
Enter and exit portfolio positions opportunistically or methodically and of course rebalance when required. A portfolio manager's alpha generation strategy and trade execution is always obfuscated by the Shielded Alpha℠ ETF wrapper's creation basket.
This ETF wrapper cannot be reverse engineered, unlike competing structures whose disseminated verified intraday indicative value is calculated from actual portfolio holdings and weightings.
2. Creation Basket
Generating the daily creation Basket for a Shielded Alpha℠ ETF is rapid and efficient because all operational workflow is hosted in Blue Tractor's secure cloud platform.
Following the close of trading (on Day T) a fund's custodial bank or fund administrator will calculate the end-of-day net asset value for a Shielded Alpha℠ ETF; no differently than done currently for a transparent ETF or mutual fund.
The fund's back office (or custodial bank or fund administrator, if preferred) then accesses the Shielded Alpha℠ cloud service through a web browser (or SFTP if batch files are used) and uploads the ETF's confidential portfolio information in simple CSV format. Seconds later a creation basket portfolio file is returned that will be used for next day's trading (on Day T+1).
Under the Shielded Alpha℠ ETF structure, the creation basket will always hold 100% of the names of the actual ETF portfolio (and there is no use of 'proxy' stocks), however the % weightings of the stocks in the creation basket will always differ from the actual % weightings in the ETF portfolio. Because all the names in the ETF are also in the basket, this is a highly transparent ETF for market makers, however the mismatch in % weightings fully hides the portfolio manager's alpha generation strategy. Additionally, the creation basket will always have a minimum 90% asset value overlap with the ETF portfolio, ensuring a high degree of correlation and low tracking error.
The creation basket portfolio (a.k.a. the portfolio composition file or PCF) is then uploaded by the custodial bank or fund administrator to the National Securities Clearing Corporation (NSCC) no later than 8 pm ET, where it will then be disseminated to all market participants for use on Day T+1 (as well as being posted on the ETF fund's website).
3. Manage the Basket
The recent SEC ETF Rule Change (Rule 6c-11) pertaining to transparent ETFs notably permits 'custom' creation baskets as they can provide ETF advisors with compelling cost and tax advantages over non-customizable pro rata creation baskets, the industry standard to date.
No differently with the new "less than fully transparent"
ETF wrappers, best-in-class active portfolio managers seeking to generate multiple sources of alpha will want to manage both the ETF fund portfolio and the creation basket.
Wrapper structures offering only a pro rata creation basket to active managers are at risk of obsolescence.
Only Blue Tractor's ETF wrapper equips active portfolio advisers with the tools to fully manage the ETF's daily creation basket. Through basket management, ETF portfolio managers can focus on (1) lowering cost and improving tax efficiency and (2) fully cloaking portfolio trading in the ETF from predators.
Cost and Tax
ETF portfolio managers can use the cloud software drop-down menu tools to manage the Shielded Alpha℠ creation basket in order to lower trading costs and boost capital gains tax efficiency during creation and redemption activity with APs. This is accomplished by simply over and underweighting select individual securities positions that are of interest. Lower trading costs and enhanced tax efficiency can translate into greater alpha for the fund.
Hiding Portfolio Trading
Portfolio managers can build new positions or sell out of positions with confidence using the Shielded Alpha℠ cloud tools. Manage the creation basket and mask all trading by over and underweighting portfolio positions as 'decoys' to completely throw off predators.
4. Capital Markets
Portfolio transparency, manifested by publication prior to each trading day of the creation basket securities (or PCF file), is a key cornerstone for the success of ETFs.
Why? Because through the published basket market makers and APs know exactly the stock specific risks they are exposed to when they post a bid/offer price, when they hedge, when they undertake arbitrage and when they create and redeem, all translating into efficient and liquid markets with accurate pricing and tight spreads.
Because a Shielded Alpha℠ ETF creation basket holds 100% of the portfolio names (but not their correct % weightings), this is a highly transparent structure (and certainly not a non-transparent ETF).
Because of this relative transparency, market makers and APs know on every trade day the risks they are exposed to, therefore they can hedge appropriately and thereby conduct efficient bona fide arbitrage and make markets with tight spreads versus competing semi or non-transparent structures. Transparency also means they have immediate knowledge of any announced trading halts of securities in the ETF portfolio; no other competing structure provides this lens to the capital markets.
No different than with a fully transparent actively managed ETF, market makers and APs can use the published Shielded Alpha℠ creation basket to generate sub-second, high frequency intraday pricing for the basket. They can use last sale or midpoint pricing or a combination thereof. They don't have to rely on a stale 1-second verified indicative intraday pricing signal from third party calculation agents as their primary (and only) pricing signal.
And with a Shielded Alpha℠ creation basket, APs can transact directly with the ETF during creations and redemptions, thereby transacting efficiently in the capital markets as they do best. There's no requirement for a third party AP Representative account and no need for an ETF to enter into multiple non-disclosure agreements with third party pricing and calculation agents.