{"id":3261,"date":"2024-03-18T20:36:00","date_gmt":"2024-03-18T20:36:00","guid":{"rendered":"http:\/\/blog.valuengine.com\/?p=3261"},"modified":"2024-03-19T01:48:52","modified_gmt":"2024-03-19T01:48:52","slug":"a-much-needed-educational-piece-about-so-called-spot-bitcoin-etfs","status":"publish","type":"post","link":"http:\/\/blog.valuengine.com\/index.php\/a-much-needed-educational-piece-about-so-called-spot-bitcoin-etfs\/","title":{"rendered":"A Much-Needed Educational Piece about So-Called \u201cSpot Bitcoin ETFs\u201d"},"content":{"rendered":"

Eight years after the first application for a \u201cSpot Bitcoin ETF\u201d was filed with the US Securities and Exchange Commission (SEC), ten of them started trading on January 11, 2024.\u00a0 The landmark decision was precipitated by Grayscale\u2019s legal victory against the SEC in 2023.<\/p>\n

Sponsors of the nine so-called \u201cETFs\u201d include well-known firms like Ark (with partner 21 Shares), BlackRock, Fidelity, Franklin Templeton, Invesco, Van Eck, and Wisdom Tree.\u00a0 These firms and others have either waived or reduced their fees in the first few months in a race to gather assets.<\/p>\n

All 5,000 stocks, 16 sector groups, 140 industries, and 500 ETFs have been updated.<\/strong><\/h6>\n
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As of March 14, after roughly two months, this table shows how the asset gathering race has gone along with the differences in expense ratios and one-month returns.<\/p>\n

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At first glance GBTC<\/strong> from Grayscale, the company whose lawsuit paved the way for Spot Bitcoin ETFs, would seem to be the early winner with $28 billion in assets under management (AUM). That is nearly double the $15 billion in IBIT<\/strong> from iShares in second place.\u00a0 However, it is the year-to-date fund flow numbers that tell the tale.\u00a0 GBTC <\/strong>had been \u201cthe only game in town\u201d prior to January 11.\u00a0 The complex trust share-issuance structure Grayscale used was a more-expensive workaround to bring bitcoin to market prior to \u201cSpot Bitcoin ETF\u201d approval. Actually, its $28 billion represents a $11 million dollar decrease in AUM, most of which have gone to less expensive competitors.\u00a0 Since the new products were launched iShares and Fidelity are dominating the asset gathering race.\u00a0 They also offer the lowest fees, albeit in both cases fee-waivers-since-inception have played into the mix.\u00a0 With 46% one-month returns and lots of hullaballoo, this has been the fastest growing category of ETFs in 2024.<\/p>\n

But\u2026are these \u201cSpot Bitcoin ETFs\u201d actually ETFs at all?<\/p>\n

From a legal structural perspective, they are not.\u00a0 True Exchange-Trades Funds (ETFs) are mutual funds.\u00a0 They are governed by the Securities Act of 1940. The major differences are that the individual shares of the fund are bought and sold on securities exchanges exactly as any other stock shares.\u00a0 However, new fund shares are only created and redeemed through authorized participants in very large quantities, generally more than $25,000 per transaction.\u00a0 These participants buy hundreds of fund shares at a time by contributing in-kind securities requested by the fund. They can be thought of as miniature replicas of the fund\u2019s constituents in the proportion held by the fund. To sell fund shares back to the fund itself, participants send the requested amount of fund shares per basket to the fund and receive baskets of the underlying securities in return.\u00a0 This complex-sounding redemption process, now done routinely every day, Is considered a free-receipt-and delivery process.\u00a0 Unlike selling securities for cash, the free-receipt-and-delivery process is not subject to capital gains tax.<\/p>\n

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A Host of Advantages to the ETF Structure for Actual ETFs<\/strong><\/p>\n

The most obvious difference between the traditional redeem-at-the-distributor model of mutual fund and an ETF is that ETF shares can be bought, sold, etc., on the exchange and through a brokerage account just like any other stock.\u00a0 Improved Flexibility.<\/strong><\/p>\n

However, that difference is just the tip of the iceberg in terms of the new structure\u2019s advantages over the old one.<\/p>\n

The result is a host of advantages to the ETF investor and some for the fund companies providing ETFs as well. When shares are redeemed, the fund\u2019s underlying securities \u2013 NOT CASH \u2013 are transferred to the redeemer.\u00a0 This is called an in-kind redemption.\u00a0 Unlike selling securities on an exchange, an in-kind redemption is not considered a sale and thus does not realize any capital gains.\u00a0 This is what is meant by ETF tax efficiency. Cost Savings. <\/strong><\/p>\n

Since shares are not redeemed for cash at the distributor, very little cash needs to be kept on hand for redemptions.\u00a0 This eliminates \u201ccash drag\u201d, having assets in cash that could be in stocks, at a time when stocks earn more than cash.\u00a0 Historically, stocks earn more than cash in more than 80% of recorded years since 1901.\u00a0 Therefore, cash drag generally hurts investor returns. Return Improvement.<\/strong><\/p>\n

A corollary to this fact is often overlooked.\u00a0 In the traditional structure when investors redeem a large number of shares, mutual funds must sell stocks to raise cash.\u00a0 To mitigate capital gains, stocks with the highest capital gains are usually not sold in favor of stocks will lower amounts of capital gains. This often results in a fund liquidating newer positions while retaining older positions.\u00a0 This is particularly problematic in actively managed funds using the old structure as you certainly want the newest investment ideas, not the stalest, from your active fund manager.\u00a0 No wonder one of the biggest industry trends in the past 3 years has been traditional active funds – who spent 20 years warning against the dangers of ETFs – now launching them. Potential Return Improvement.<\/strong><\/p>\n

Instead of arcane forward pricing at Net Asset Value (NAV), shares are bought and sold immediately on the exchange which means traders know their costs and can fix their risk at a specific price at the time trade is submitted. If the market seems to be beginning a sell-off at 10 AM, shareholders have the ability to sell then instead of waiting for what could be a much greater fall at 4 PM.\u00a0 Very few people would agree to buy or sell a car at a price to be determined at the end of the day.\u00a0 Why should mutual fund investors do so? Price Risk Management Improvement.<\/strong><\/p>\n

Another benefit to mutual fund companies is cost savings.\u00a0 ETFs have simplified transfer agency operations because the beneficial owners are the relatively small number of authorized participants dealing directly with the fund.\u00a0 All other shareholders are handled through their brokerage accounts and are not direct customers of the ETF. Efficiency and Cost Savings Improvements.<\/strong><\/p>\n

All of the above is discussed in my published paper \u201cLeveling the Playing Field for Active Managers\u201d available on the ValuEngine site at https:\/\/www.valuengine.com\/pub\/main?p=32<\/a><\/p>\n

The ETF Structure vs. The \u201cETF Wrapper\u201d<\/strong><\/p>\n

Another term the investment industry and financial media (\u201cexperts\u201d) use to describe launches is the \u201cETF wrapper.\u201d\u00a0 \u201cWrapper\u201d has no standing in investment law or with the SEC.\u00a0 It is old mutual fund jargon about different classes of fund shares offered to differentiated types of investors (e.g., 401K plan, High New Worth, etc.).\u00a0 Since all types of investors have equal access to buy and sell ETF shares at the same price and fees and tax treatments, the word \u201cwrapper\u201d shouldn\u2019t really apply.\u00a0 Moreover, I believe it demeans the actual structural advantages of the Exchange-traded fund.\u00a0 It probably should have been nicknamed ETMF in the beginning.\u00a0 However, ETF\u201d was deemed by marketing experts at pioneering firms to be more catchy than ETMF.<\/p>\n

At any rate, \u201cexperts\u201d describe mutual funds now structured as ETFs as \u201cbeing in the ETF wrapper.\u201d\u00a0 Unfortunately, they also describe many other products as ETFs with the justification that \u201cthey use the ETF wrapper.\u201d<\/p>\n

Using ETF to describe something not associated with a mutual fund is not a new sleight-of-tongue.\u00a0 Experts have done it for years over the objections of sticklers like me.<\/p>\n

The trend started with GLD, <\/strong>a depository receipt on physical gold, launched by State Street Global Advisors in cooperation with the World Gold Council in 2003.\u00a0 The structure was modeled after an ADR using the legal vehicle of a special type of trust called a Grantor Trust.\u00a0 A share of GLD <\/strong>is a share of a trust that can hold precious metals, foreign stocks, land deeds and many other things.\u00a0 The shares trade on stock exchanges.\u00a0 Upon sales, investors are taxed as if they had sold a pro rata portion of the underlying.\u00a0 Thus, they do not have the tax advantages of ETFs but a different tax treatment altogether.<\/p>\n

This watershed event explains how products reflecting non-traditional-assets-with-financial-value that use the Grantor Trust and similar structures are now commonly called ETFs despite the fact that there is no actual fund associated with the product.\u00a0 Other products called ETFs with no fund include:<\/p>\n