Simon Goulet and Terence Norman, co-founders of Blue Tractor Group, recently discussed with SS&C ALPS the challenges and opportunities of the Shielded Alpha℠ ETF wrapper. Blue Tractor’s Shield Alpha℠ was one of four semi-transparent models that were approved by the SEC late in 2019.
What do you feel gives your Shielded Alpha℠ methodology an advantage over the other recently-approved NextGen ETF models?
Blue Tractor’s Shielded Alpha℠ ETF wrapper methodology (1) provides asset managers with the opacity necessary to fully obfuscate their alpha generation strategy (the ‘secret sauce’), perfectly balanced with (2) the transparency required by market makers, authorized participants and other institutional investors to make efficient and liquid primary and secondary trading markets.
Unlike the other ‘proxy portfolio’ NextGen ETF models, with Blue Tractor’s highly transparent wrapper the daily creation basket only holds 100% of the underlying portfolio names. No decoy securities are ever used and no portfolio stocks are omitted. And as compared to other wrappers, our structure does not require additional operational workflow using an AP-Representative entity or VIIV calculation agents. These only add to cost and inefficiencies.
However, in the Blue Tractor creation basket, the percentage weightings of the securities in the basket are not pro-rata and will always differ from their correct percentage weightings in the underlying portfolio. Furthermore, the weighting scheme of the securities within the creation basket have a guaranteed minimum 90% overlap with the security weighting scheme within the underlying portfolio.
It is the daily mismatch in percentage weightings between the basket and the actual undisclosed ETF portfolio that completely hides the asset manager’s alpha generation strategy because a predatory actor will never know if the percentage weightings changes seen in the daily published basket are actual portfolio trading or are simply artifacts of the Blue Tractor algorithm. And because 100% of the portfolio names are revealed along with a minimum 90% asset value overlap, the Blue Tractor ETF wrapper is indisputably highly transparent.
The Blue Tractor wrapper’s inherent transparency offers numerous and significant advantages over the other NextGen ETF models:
- Market makers will always know the securities they are exposed to with the Shielded Alpha℠ basket (and can therefore quantify and fully hedge their risks), so they are able to effect tighter and more liquid markets than non-transparent ETF wrappers;
- Tight spreads and more liquid markets translate into a better ‘client experience’ for retail investors in all types of market volatility;
- During a creation, an asset manager will only receive stocks from the authorized participant that they own. Conversely, in a redemption, the asset manager only has to deliver stocks to the authorized participant that they already own; and
- As fiduciaries, RIAs will always know from a quick glance at the daily basket what exact securities their retail clients are exposed to.
The Shielded Alpha℠ wrapper offers additional compelling features versus the other NextGen ETF models:
- The Only True Turnkey Solution
Unique to Blue Tractor, all workflow to generate the daily Shielded Alpha℠ ETF creation basket is through a secure cloud-hosted service. There are no operational changes required with respect to daily portfolio management and the workflow by the ETF custodian or administrator to generate the daily creation basket seamlessly integrates into what already happens today for a fully transparent ETF.
- Basket Management
Using Blue Tractor's cloud platform, asset managers can modify one or more securities' weightings in the Shielded Alpha℠ Creation Basket to (1) eliminate trading costs and (2) enhance portfolio tax efficiency. Moreover, these same basket management tools are used to (3) fully cloak portfolio trade execution when entering into a new position or exiting from one.
What types of products do you foresee asset managers launching when the first Shielded Alpha℠ funds come to market? Do you still expect domestic equity to kick things off, or may we see other asset classes as well?
Under Blue Tractor’s current exemptive relief, the investable universe consists of domestic all-cap equity securities, ETFs, ADRs, other US exchange-traded instruments, including preferred stock and futures, and treasuries. The SEC also permits asset managers using the Shielded Alpha℠ wrapper to invest in foreign equity securities from markets that trade contemporaneously with the US – so think Canada, Mexico, and Brazil. So, asset managers have some flexibility in the equity asset classes they wish to initially utilize.
In early January 2020, Blue Tractor filed with the SEC for an expanded investable universe, including domestic and foreign fixed income instruments, foreign equity securities from Europe, Asia, etc., other derivative instruments including options, and currencies.
All types of actively managed strategies are possible using the Shielded Alpha℠ wrapper, be it large, mid, small or all-cap, momentum, growth, value, concentrated, etc.
We mentioned in our whitepaper that one of the big initial challenges will be getting these new NextGen ETFs on intermediary platforms. How have you addressed this challenge, and how do you foresee acceptance being gained for new Shielded Alpha products to be listed on these distribution platforms?
The ‘entry criteria’ for an ETF utilizing a new active wrapper structure vary from platform to platform, but the key elements for all is a trading history of six months plus (including trading spreads, accurate pricing vs. NAV, etc.) and a minimum level of AUM in the ETF. Certainly, some of the platforms are more aggressive regarding the ‘entry criteria’.
Another vital element consistently mentioned by all the platforms regarding the new ETF wrapper structures is what will the “client experience” be under all market conditions. The recent whipsaw markets driven by fears over the coronavirus serves to underscore why ‘client experience’ is of primary concern because as market volatility increases, spreads will certainly widen and liquidity could be withdrawn for any new wrapper structure that is unable to provide market makers with the transparency required to conduct orderly and efficient primary and secondary markets. From our discussions with the platforms, we are confident that these concerns are minimal for the Blue Tractor wrapper because of its inherent high degree of transparency.
Additionally, another key variable that all the platforms and investment advisors in general face by mid-year 2020 are the new Regulation Best Interest requirements. Without a doubt, ‘Reg BI’ considerations are going to influence investment advisors and the platforms about which wrapper structures provide investors with the best ‘client experience’ under all market conditions. We are certain that the inherent transparency with the Shielded Alpha℠ wrapper best meets the fiduciary criteria under Reg BI.
What is the biggest misconception that firms might have about the Shielded Alpha℠ model?
Upon an initial review of the details of the Shielded Alpha℠ structure, some asset managers have voiced the misconception that the Blue Tractor wrapper exposes too much of their confidential portfolio details to the market (because the ETF creation basket will disclose daily 100% of the actual portfolio names, but importantly under the Blue Tractor wrapper, NOT their actual percentage weightings). However, this misconception is quickly allayed when the asset manager realizes that portfolio names in of themselves do not expose their ‘secret sauce’ to the market. Simply knowing a portfolio name does not provide insight into (1) why did the manager purchase the security (2) is the position over or under the relevant benchmark weighting and (3) what is the target weighting and holding period.
Additionally, most active managers are benchmarked against a passive index. So, in order to capture at least the market return, everybody already knows the key stocks in the confidential portfolio. For example, an active tech fund manager benchmarked against the S&P North American Technology Sector Index will have to own AAPL, FB, GOOG, AMZN, etc. But what a predatory actor does not know from observing the Shielded Alpha℠ creation basket is whether the ETF’s positions in AAPL, FB, GOOG, and AMZN are over or under the index weighting. This uncertainly when monitory the daily, ever-changing Shielded Alpha℠ creation basket percentage weightings fully shields the manager’s ‘secret sauce’.
We also would emphasize that with a few clicks of the mouse when using the Shielded Alpha℠ cloud software, asset managers can also completely cloak when they initiate a new position or when they exit from one, by adjusting the percentage weightings of one or more instruments in the creation basket.
Wanting to learn more about Shielded Alpha℠? Read the SS&C ALPS Semi-Transparent Exchange Traded Funds: A Revolution in Active Management Whitepaper.
Asset Management, Wealth Management