With 4778 exchange-traded funds (ETFs) in existence, what’s one more? In October 2013, J.P. Morgan Chase filed with the Securities & Exchange Commission to announce its long-awaited entry into exchange-traded funds, with the creation of the J.P. Morgan Global Equity ETF.
The filing is notably sparse in defining the fund, with telltale blanks appearing in several key areas. In particular, there are questions as to where the firm is to list which index the fund will correspond with, how large management fees will be,and what the ETF’s other expenses will consist of.
However, the SEC filing does let on that the J.P. Morgan Global Equity ETF - which has yet to carry a ticker symbol - will select its components from global market equities of high relative value, upward momentum, high stability and certain levels of market capitalization.
Not Exactly A Surprise
It isn't an overnight process for an investment firm to create an ETF and sell shares. J.P. Morgan initially filed its ETF intentions with the SEC four years ago, with the idea of creating not just one ETF, but a series. The majority of those funds still remain in the research and development stages, if that.
Per the SEC application, J.P. Morgan’s actively-managed ETF aspirations include the XF Physical Copper Trust, backed by tangible reserves of the precious metal. As of early 2014, we’re still waiting for that ETF’s initial public offering.
Historically, J.P. Morgan’s asset management arm has been reluctant to create its own company-branded ETFs. But while J.P. Morgan didn’t sell ETFs under its own name, it was nevertheless a huge player in the market. The company made money as a service provider and custodian to more than 100 other ETF firms.
So why is J.P. Morgan getting into the ETF game now? (Note: “Game” is just a colloquialism there. Investing is never a game.) For one thing, actively managed ETFs offer fundholders a modest tax bite - more of a nibble, really - compared to their mutual fund counterparts. Fewer capital gains distributions mean that the IRS can levy in less capital gains taxes, thus giving actively managed funds an intrinsic advantage.
Despite the Global Equity ETF being J.P. Morgan’s first such branded fund, the bank has taken credit for bringing several innovations to the ETF market, such as the class-of-share ETF, whose components are distinguished by level: Class A stock, Class B etc., and the enhanced index ETF, created by initially tracking an index, then modifying the fund’s composition using various criteria. The components are then weighed by fundamentals such as net income and book value, or by industry sector, etc.
In addition, J.P. Morgan claims invention of the inverse index ETF, a bearish instrument consisting of short positions in various issues. J.P. Morgan also spearheaded the first ETF to offer short positions of issues in an index while simultaneously modifying the components - the enhanced inverse ETF. Investors have spoken about these developments approvingly; enhanced, inverse, and enhanced inverse ETFs now number in the dozens.
According to J.P. Morgan’s own internal documents, the company has held off on directly selling ETFs for at least one strategic reason: federal securities law requires actively managed ETFs to disclose their entire makeup daily. In theory, that would make it possible for a broker to profit by buying shares in a new ETF component before telling clients that said issue would be joining the ETF.
For the future, J.P. Morgan is counting on the SEC allowing less transparency among actively managed ETFs. The firm has argued that mandating full daily disclosure will lead to the creation of fewer such ETFs. (If the idea of more opacity sounds negative - the kind of thing that regulators should prohibit out of hand - it isn’t quite that simple. Ordinary mutual funds have an advantage over ETFs in that they only need to disclose their portfolios every 3 months. That means that mutual funds have little reason to be unduly speculative.)
The question remains, how will the J.P. Morgan Global Equity ETF differentiate itself from its competitors?. Unlike mutual funds as a whole, the overwhelming majority of U.S. ETFs are passively managed, and those outliers have a mere $9.6 billion under management. The market for this particular class of security seems ready for exponential growth. As to which index J.P. Morgan’s first true ETF will track, or what criteria will go into determining the ETF’s composition, the secrets remain closely guarded.
Even though J.P. Morgan is nominally new to the development and sale of its own ETFs, it’s not as if the firm was the only Wall Street titan to spend decades on the sidelines. while smaller firms did the work. In fact, it was only in the last five years that such major players as Goldman Sachs, Vanguard, Pimco and T. Rowe Price entered the ETF market and then came to dominate it.
Before now, the closest J.P. Morgan came to offering an ETF was the Aleria Master Limited Partnership exchange-traded note. ETNs are the debt-based equivalents of exchange-traded funds, and this one has so far failed to keep pace with movements in the S&P 500. Granted, that’s more emblematic of the bond market itself than of any inherent shortcomings in the Aleria MLP ETN.
The Bottom Line
For months now, since the SEC filing became public knowledge, J.P. Morgan’s executive team has kept its lips tight regarding its nascent ETF operations. The executive in charge of J.P. Morgan’s global funds operations does acknowledge that active management has to provide value that passively managed mutual funds can’t offer. His employer might be in a position to do something memorable, if it can quantify that value in this new endeavor.