The battle between active and passive investment managers in the U.S. has been tilting decidedly toward the index crowd in recent years, as evidenced by the inflow of $413.8 billion into passively managed funds in 2015. But after some four years of development and regulatory red tape, Boston-based Eaton Vance finally rolled out in late February what it hopes will be ammunition for the active management camp: NextShares, its patented hybrid product that offers mutual fund portfolio management dressed up as an ETF.
Eaton Vance CEO Tom Faust has touted the product as handy tool to stanch the outflow of actively managed funds into cheaper passive vehicles. Other major asset management firms, including American Beacon Advisors and Hartford Funds, have been impressed with the idea and signed on to the NextShares wrapper.
Despite the mounting anticipation, though, the NextShares vehicle has gotten off to a slow start since the February 26 launch of the first of 18 planned funds. Over the roughly five weeks since it has been open for trading on Nasdaq, equity strategy fund Eaton Vance Stock NextShares (EVSTC) has garnered just $1 million in inflows. Two more funds launched on March 30.
“The pickup of these funds is going to take time,” says Todd Rosenbluth, U.S. director of ETF and mutual fund research at S&P Capital IQ in New York. “The investors who will initially see the value of this will be the ones who appreciate Eaton Vance’s target capabilities.”
Market watchers, as well as Faust, have given at least two reasons for the slow uptake so far: a lack of familiarity with the product and limited distribution channels. “It’s a new product, with a history that goes back just more than 30 days, so I guess it’s a fair criticism to say that there aren’t many investors who have long personal experience with NextShares,” Faust tells Institutional Investor. “It’s early. People aren’t familiar with this because it’s new, though there’s nothing inherently complicated about the funds.”
The funds are officially designated by the Securities and Exchange Commission as exchange-traded mutual funds (ETMFs). Essentially, these are existing Eaton Vance mutual funds that trade as actively managed ETFs, though without the daily transparency required of traditional ETFs. Rather, NextShares discloses portfolio holdings on a quarterly basis, as is typical of a mutual fund. This structure prevents front-running. At the same time, the funds offer the tax benefits of ETFs, which tend to generate fewer capital gains than mutual funds. The NextShares funds trade on Nasdaq, with pricing determined by the funds’ end-of-day net asset value. So far, EVSTC has traded within 5 basis points of NAV, which has been “very tight relative to the underlying value,” Faust says. “It’s a simple and straightforward process for market makers to take positions in the funds. This translates into consistently low trading costs,” especially when compared with other methods of delivery for mutual funds.
So far, though, the low trading costs have not been sufficient enticement for investors to jump in. “People will be watching from the sidelines until this gains more momentum,” says Alex Bryan, an ETF and mutual fund analyst at Morningstar in Chicago. Faust, acknowledging the newness of NextShares to investors, sees only a “short learning period” before others get more comfortable with ETMFs. As for the strategies themselves, the first three funds use the same underlying portfolio as existing NextShares funds via a master feeder structure, so investors who follow Eaton Vance will know what they’re getting into, he says.
Initial hesitation aside, investors can’t buy into the product if they can’t access it. To date, only one broker-dealer offers NextShares: Folio Investing, an online brokerage firm that Faust admits has a “relatively small footprint.” Until a wider distribution network comes online, both he and analysts expect inflows to remain modest. S&P Capital IQ’s Rosenbluth sees the very limited distribution network as the primary challenge in attracting assets. The other firms that originally signed on to license the NextShares structure for their own funds, such as Mario Gabelli’s GAMCO Investors, are likely holding back until the distribution kinks get worked out. “Other firms are not going to want to launch until there is a use case that works and there are brokerage platforms that bear any execution,” Rosenbluth continues.
Wider distribution will also help NextShares withstand the prevailing market winds, Faust maintains. Deborah Fuhr, managing partner of ETFGI, an ETF consulting firm in London, points out that NextShares launched during one of the worst yearly starts for equities. The SEC granted Eaton Vance approval for the ETMF late last year, and the firm needed to strike while the iron was hot. “When you get SEC approval, you want to take advantage of that,” she says. “You don’t want to sit on it.”
So will NextShares win back some investors from passive funds? In the face of initial tepid reception, Faust is confident. “The delivery of active management has been too expensive,” he says. Nonetheless, familiarity is key. The first ETF in the U.S. was released in 1993, but, as Fuhr mentions, ETFs didn’t really take off until 2000.
The battle continues.
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