In his 35-year career on Wall Street, McCabe has seen changes
in regulation and technology disrupt the business model of trading
stocks and options. After working in sales, options trading, and
index arbitrage at various brokerages, he rose to lead Bear Hunter
Structured Products LLC, a unit of a so-called specialist that helped
make markets on the New York Stock Exchange and American Stock
Exchange. But new Securities and Exchange Commission rules
in 2007 ushered in an electronic age, weakening the grip that
specialists and exchanges had on markets. Today, computerized
high-speed traders such as Virtu Financial Inc. and Citadel Securi-
ties rule the markets, including arbitraging ETFs.
So more than 10 years ago, McCabe and his partners—all from
sales and trading backgrounds—turned to reinventing active money
management, another business that was being disrupted.
Now 55, McCabe has spent the last decade educating regu-
lators, asset managers, and brokers about how to trade a fund that
doesn’t disclose its holdings every day. To price conventional ETFs,
market makers use real-time information about the value of a fund’s
holdings. When a fund’s price falls below the aggregate value of its
components, these electronic traders step in to buy shares in the
fund and redeem them for the underlying securities, profiting from
the difference. This arbitrage keeps the price of the ETF in line with
its value—but it requires portfolio transparency.
Under McCabe’s model, market makers will use an indicative
value of the holdings published by the fund every second to judge
whether its price is too high or low, rather than scrutinizing its port-
folio. And when they buy discounted ETF shares to redeem for higher-
value holdings, they won’t deal directly with the fund or end up with
those stocks. Instead, an agency broker will confidentially receive the
securities and sell them for cash that it returns to the market maker.
McCabe’s structure finally secured regulatory approval in May.
“By the nature of the product, there are going to be wider
spreads on account of the additional uncertainty—especially in
the early days,” says Craig Messinger, CEO of Virtu Americas, aInvestment Management
One Man’s Crusade to Reinvent
Mutual Funds for the ETF Era
By RACHEL EVANS
DAN MCCABE IS on a quest to transform your finances. The chief
executive officer of Bedminster, N.J.-based Precidian Investments
has a new way to invest that could make thousands of mutual
funds obsolete, and he’s persuaded the likes of BlackRock Inc. to
license the idea.
His big pitch? An exchange-traded fund that hides its holdings.
Active managers have largely steered clear of the rapidly expanding
$4 trillion U.S. market for ETFs, fearing that the daily disclosure
these funds require would compromise their secret sauce. But
McCabe’s patented structure allows ETFs to report once a quarter,
like a mutual fund, protecting that intellectual property. As a result,
stockpickers’ most popular strategies could be coming soon to an
exchange near you.
Roughly $7.2 trillion in mutual fund strategies may ultimately
work within this wrapper, according to analysts at JPMorgan Chase
& Co., which may also issue these products. The first ActiveShares
funds, as McCabe’s model is branded, are scheduled to start trading
within months. They’re aimed at investors who desire the lower
cost and liquidity of an ETF but also want to beat their benchmark.
The growing popularity of passively run funds—like most
ETFs—has drained active managers’ assets. Index-huggers now
manage about 40% of assets in the U.S., up from less than 10% two
decades ago, according to Morningstar Inc.
Cost is a major factor behind this shift. Tracking an index is
cheaper than hiring a star manager, but that’s not the only reason
ETFs are pushing management fees toward zero. ETFs are also
inherently cheaper than mutual funds because they don’t need the
same administrative support: They don’t maintain a record of their
owners, they typically don’t pay incentives to distributors, and they
shield investors from capital gains taxes by using securities to pay
off redeeming fund holders.
By eliminating these costs, active funds could charge a lower
fee, allowing the merits of their investing strategies to shine
through—in theory, at least.
30