Capital Markets Desk: The ETF Rule Has Finally Arrived!

Some thoughts on the recent adoption of the ETF Rule and what it means for investors.

    David Mann

    David MannHead of Global ETF Capital Markets, Franklin Templeton

    At the start of 2018, I predicted regulators might adopt a new Exchange-Traded Fund (ETF) Rule, and then also discussed the rule proposal in a little more detail. And, I gave our feedback on the Rule via a comment letter.

    The Securities and Exchange Commission (SEC) finally announced the adoption of the ETF Rule, which will soon go into effect. The SEC stated the Rule is designed to modernize the regulation of ETFs by establishing a clear and consistent framework for the vast majority of ETFs operating today, and will facilitate greater competition and innovation in the ETF marketplace. It will also allow ETFs to come to market more quickly.

    I think it will certainly even the playing field among ETF issuers. I wanted to reiterate that this rule treats active and index funds the SAME if the conditions are met. From the final rule:

    “Index-based and actively managed ETFs that comply with the rule’s conditions function similarly with respect to operational matters, despite different investment objectives or strategies;” and,

    “The distinction between index-based ETFs and actively managed ETFs in our current exemptive orders is largely a product of ETFs’ historical evolution…The Commission has observed how actively managed ETFs operate during this time, and has not identified any operational issues that suggest additional conditions for actively managed ETFs are warranted.”

    The above has been an ongoing issue when discussing our entire suite with investors as they often push back on our active ETF offerings for the simple reason that they have the “active” label. This rule explicitly states that from an operational perspective, they are largely the same, and we hope that over time, investors will start evolving their thinking on active ETFs.

    We saw a great example of this in action recently with our active low volatility fund, Franklin Liberty US Low Volatility ETF (FLLV). This fund just celebrated its three-year anniversary on September 22, 2019, with assets under management of only $18 million. The most common excuse for the lack of adoption of this fund we have heard among investors is that it’s an “active” fund, as in actively managed. Investors often consider the term ETF to mean a passive index-tracking fund.

    On Monday (9/23/19) an investor bought 1M shares ($37M) of FLLV within the bid/ask spread which was 3 cents at the time of the trade. 

    All the content we have written about ETF liquidity and leveraging the underlying basket applies to both active and passive, as was evident in this trade. Now, we finally have an ETF rule supporting that point as well, which in turn will allow active ETF issuers access to all the same tools (such as custom baskets) that have been available to index funds for quite some time.

    The comments, opinions and analyses expressed herein are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.

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    What Are the Risks?

    All investments involve risks, including possible loss of principal. Generally, those offering potential for higher returns are accompanied by a higher degree of risk. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. There can be no guarantee that the fund's volatility strategy will be successful, and achieving the fund's volatility strategy does not mean the fund wiII achieve a positive or competitive return. The volatility strategy can also be expected to limit the fund’s participation in market price appreciation when compared to similar funds that do not attempt this strategy. Smaller- and midsize-company stocks have historically experienced more price volatility than larger-company stocks, especially over the short term. These and other risks are discussed in the Franklin Liberty US Low Volatility Fund's prospectus. Investors should carefully consider a fund’s investment goals, risks, charges and expenses before investing.

    For actively managed ETFs, there is no guarantee that the manager's investment decisions will produce the desired results. ETFs trade like stocks, fluctuate in market value and may trade at prices above or below their net asset value. Brokerage commissions and ETF expenses will reduce returns. ETF shares may be bought or sold throughout the day at their market price, not their Net Asset Value (NAV), on the exchange on which they are listed. Shares of ETFs are tradable on secondary markets and may trade either at a premium or a discount to their NAV on the secondary market.

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