January 14, 2002
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Attn: Mr. Jonathan G. Katz, Secretary
Re: Release No. IC-25258; File No. S7-20-01 - SEC Concept Release: Actively
Managed Exchange-Traded Funds
Dear Mr. Katz:
Susquehanna International Group, LLP ("SIG") appreciates this opportunity to comment on the U.S. Securities and Exchange Commission's (the "Commission's") concept release requesting comment regarding various issues related to actively managed exchange-traded funds ("ETFs"). SIG, through its affiliate, Susquehanna Investment Group, is currently the designated specialist on the primary exchange in 19 ETFs, which account for nearly two-thirds of the approximately $5 billion of current daily secondary market trading volume of U.S. listed ETFs. The market indices associated with the ETFs in which SIG serves as specialist vary substantially by capitalization, style, sector, domestic market and liquidity, and include those that track the NASDAQ 100 trust (QQQ), MSCI EAFE (EFA), Russell 2000 (IWM), MSCI South Korea (EWY) and S&P MidCap 400 (MDY). Accordingly, SIG has gained substantial experience and understanding of various factors, including secondary market price discovery and degrees of liquidity, that contribute to the overall usefulness of ETFs as efficient investment vehicles.
During the past few years, the popularity of ETFs has grown dramatically due to the efficiencies and other benefits that they afford investors. More specifically, investors enjoy the benefits of intraday liquidity when both purchasing and selling interests in ETFs. Unlike mutual fund investors, ETF investors do not have to wait until the end of a trading day in order to determine the price at which they purchased or sold their ETF investment. ETF investors can therefore utilize the mechanisms offered by the United States securities exchanges and alternative trading systems to know with certainty the price at which they are purchasing or selling their investments. Moreover, an investor wishing to purchase or sell an ETF can do so at any time during the trading day by simply calling his or her broker without completing the substantial documentation or experiencing some of the delays that may occur with mutual funds. ETFs also create efficiencies in portfolio management, thus creating cost savings that ultimately benefit fund investors. Unlike mutual fund managers, ETF portfolio managers are able to fully deploy all capital invested without the distraction of managing a cash reserve to accommodate sudden redemption requests from investors. This ability to disassociate fund management from redemption requests also protects ETF investors from the adverse tax effects that may result when a mutual fund manager needs to sell investments to honor capital withdrawal requests. ETF expense ratios are also often lower than mutual funds as selling and other infrastructure expenses are reduced as a result of the reliance on exchange mechanisms and the brokerage community to perform functions provided by the mutual funds.
To date, all ETFs have been designed to replicate the performance of a particular market index. Recently, market participants have expressed their interest in developing ETFs with portfolios that do no seek to replicate an index, so called actively managed ETFs. SIG believes that an expansion of the universe of ETFs would further benefit investors and heighten the popularity of ETFs. To accomplish this expansion, SIG suggests a two-pronged approach. First, SIG would propose that the Commission permit the development of ETFs the portfolios of which are not strictly based on an index, but that are readily ascertainable. Second, SIG would propose a structured deployment of truly actively managed ETFs into the marketplace.
Clearly, the level of transparency in the portfolio holdings of existing ETFs has been a primary focus of the Commission and a crucial component of the success of these products. However, ETFs other than those that seek to replicate the performance of a particular market index can also provide sufficient levels of portfolio transparency to investors. More specifically, ETFs with readily ascertainable portfolios would provide the necessary information and afford adequate protection to investors.
For example, ETFs that seek to achieve a multiple (or the reverse) of the performance of a market index would automatically afford investors a high level of inherent portfolio transparency and protection. This is so, because such ETFs would merely utilize various leverage techniques, including futures, options and other derivatives of the relevant index and/or its component securities, to achieve their stated performance levels. Accordingly, investors would have near certain knowledge of the securities in the portfolios of such ETFs. As such, SIG submits that the development of ETFs with readily ascertainable portfolios is consistent with the Commission's current reasoning, satisfies the Commission's concerns and, as such, should be permitted and promoted.
In fact, SIG submits that the definition of "actively managed ETFs" may already permit the development of ETFs that seek to achieve a multiple (or the reverse) of the performance of a market index. The Commission defines an "actively managed ETF" as an ETF with an actively managed portfolio that does not seek to replicate the performance of a particular market index. First, a strong argument can be advanced that an ETF that is merely a multiple (or the reverse) of a stated index does replicate the performance of an index with a multiplier. However, even if these ETFs are not considered to replicate the performance of a particular market index, the portfolios must be "actively managed" to be deemed to be an "actively managed ETF." This determination requires a very broad interpretation of the phrase "actively managed" and disregards the fixed universe of securities that could be components of such a portfolio. SIG suggests that a more narrow and literal interpretation of the phrase "actively managed" would be appropriate. This is especially true in light of the fact that existing ETFs that seek to replicate the performance of a particular market index are required to utilize futures, options and other derivatives to offset their transaction costs and actually replicate the return of the index.
With respect to the development of truly actively managed ETFs, SIG notes the Commission's concern that although actively managed ETFs will share some of the same characteristics as existing ETFs, there may be significant structural and operational differences between the two products. SIG agrees that actively managed ETFs will likely have different characteristics than existing ETFs, but does not believe that it or other market participants could accurately quantify the amount of deviation that should exist between the two. Instead, SIG believes that the appropriate arbiter of this determination is the marketplace itself. SIG readily encourages the development of new securities products, with those that are successful thriving and those that are not successful either adapting or going by the wayside.
Although SIG is in favor of the development of all actively managed ETFs, it believes that investors would be benefited if actively managed ETFs were introduced in groups, with those that are likely to provide the most portfolio transparency being introduced first. As such, if despite SIG's position above, ETFs that have readily ascertainable portfolios (e.g., ETFs that seek to achieve a multiple (or the reverse) of the performance of a market index) are nevertheless considered to be actively managed, these ETFs should be introduced first given their high level of portfolio transparency. ETFs that provide decreasing levels of inherent portfolio transparency would follow in order. The portfolio managers of these latter groups of ETFs would then be charged with determining the appropriate level of transparency of their portfolios, with the marketplace ultimately determining the success of these products.
Thank you for your consideration.