ETFs Need Their Own Accounting Rules- Part III- Emerging Markets ETFs

Posted by Investment Management Group on Sep 27, 2011 5:56:03 PM

There are several emerging markets that do not allow for in-kind transfers of securities, for example Brazil and India. Additionally, some countries, such as Brazil, impose a tax on new purchases of their currency. When units are created in ETFs that focus on these emerging markets, cash is contributed by the authorized participant (“AP”) in lieu of securities since an in-kind transfer is not possible. The ETF then uses this cash to purchase the securities requested at creation. Along with this cash in lieu, the ETF and the AP typically agree to lock in the price of the securities at the time of creation. If the price of the securities rise from the time of creation until the time the Fund is actually able to purchase the securities, the AP makes an additional cash contribution to the Fund to cover the increase in cost. If the prices decrease, the Fund returns cash to the AP. Additionally, the AP typically agrees to reimburse the Fund for costs incurred to acquire securities that were not able to be transferred in kind, such as transaction costs and taxes (i.e.Brazil currency).

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ETFs Need Their Own Accounting Rules- Part II- The ETF Fair Value Dilemma

Posted by Investment Management Group on Apr 16, 2010 9:48:26 AM

It is imperative for open-end investment companies to value their investments at fair value when determining their net asset value ("NAV"). For investment companies that invest a significant portion of their investments in foreign securities, the importance of fair value is magnified. Due to different time zones, many foreign exchanges close well before the close of the U.S. markets. If significant events occur after the close of the foreign markets, but before the close of the U.S. markets, the closing price of the foreign investments will not be reflective of the current market value. This creates arbitrage opportunities for market timers. Market timers look to profit from these arbitrage opportunities and do so at the expense of the remaining shareholders of the fund. To combat market timers, most mutual funds that invest in foreign securities utilize fair value factors to adjust closing foreign prices to reflect events occurring after the close of the foreign markets but before the close of the U.S. markets. Some funds establish a threshold or trigger of movement that must occur before applying the fair value factors, but more and more funds are beginning to apply fair value factors on a zero threshold basis.

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ETFs Need Their Own Accounting Rules- Part I

Posted by Investment Management Group on Apr 15, 2010 11:10:17 AM

As I am starting to work with more and more Exchange Traded Funds (ETFs), it is becoming increasingly apparent that they need their own specific set of accounting and reporting rules. Currently, an ETF falls under the guise of an open-end management investment company registered under the Investment Company Act of 1940. While this classification is technically correct, there are certain rules / guidance for open-end 40 Act investment companies that really do not make sense for an ETF. One example is the method by which Total Return is required to be calculated. Another, while admittedly more debatable, is the use of fair value adjustment factors when valuing investments domiciled on foreign exchanges for the purposes of determining the daily net asset value (NAV) of the ETF.

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