Page 38 - Investment Advisor March 2022

ETF ADVISOR

By Nicholas Morgan and Bernice Napach

Is the SEC Costing Index ETF Investors Money?

Also, potential dangers of VIX ETFs, ETNs, and Vanguard launches
first impact fund.

he exchange-traded fund mar-
ket continued its explosive
Tgrowth in 2021, and more of the
same is expected in 2022. According to
one report, 445 new ETFs launched in
2021, compared with 309 in 2020, with
hundreds more on the way this year.
When investors own shares of an ETF
index fund, however, they probably don’t
expect the Securities and Exchange
Commission’s disclosure rules to hand
some of their potential profits to other
“strategic” market participants.
But that appears to be the case,
according to a recent academic paper,
Should Passive Investors Actively
Manage Their Trades?, by Sida Li of
the University of Illinois, Urbana-
Champaign. The report estimated $3.9
billion per year is being captured from
certain ETFs by traders who use pub- A recent study estimated that $3.9 billion
licly disclosed daily portfolio informa- per year is being captured from certain
tion to pre-position trades ahead of ETF
index fund balancing trades. A combi- ETFs by traders who use publicly
nation of SEC-required daily portfolio
disclosures and “mechanical rebalanc- disclosed daily portfolio information to
ing” by ETF index funds could result
in $29,000 of losses for an investor who pre-position trades ahead of ETF index
accumulated a $2 million retirement
portfolio over 30 years. fund balancing trades.
Although this issue has been brewing
for years, only in December 2020 did Oct. 1, 2018 letter to the SEC: Invesco and Vanguard, noted their “con-
compliance become mandatory for the “… a key impediment holding [us] cerns about ‘front-running,’ ‘piggy-back-
SEC rule, requiring some ETFs to make back from offering more actively man- ing’ and the potential ability to reverse
their portfolio holdings publicly avail- aged ETFs is our concern about poten- engineer active investment strategies”
able on a daily basis. tial negative consequences associated and the potential that disclosure would
In 2018, during the SEC’s consid- with daily portfolio disclosure — spe- enable “other market participants to
eration of the proposed rule, several cifically, the risks of front-running by front-run trades.”
major fund companies pointed out an other market participants and ‘free rid- Significantly, the SEC was told: Any
unintended consequence of compel- ing’ by market participants who are able costs associated with this front-running
ling public portfolio disclosure that to reconstruct and replicate our propri- activity will likely be passed along to
could actually harm investors. As JP etary insights and strategies.” ETF investors in the form of wider bid- Adobe Stock
Morgan Asset Management put it in an Similarly, two other fund companies, ask spreads and premiums/discounts.

36 INVESTMENT ADVISOR MARCH 2022 | ThinkAdvisor.com