What the US can learn from Sweden about how to launch a bitcoin fund

Many Americans are tired of hearing about how Scandinavian societies have figured out how to do everything better than us, but here’s one more: how to launch a bitcoin fund.

The Securities and Exchange Commission and ETF companies can’t agree on how to bring a bitcoin exchange-traded fund to market. Just last week four prospective bitcoin ETF issuers withdrew their filings for new funds tracking the digital currency after the SEC shot them down, citing concerns about trading liquidity and valuation of underlying bitcoin futures.

But a Swedish company has proved how it can be done. It has successfully run a bitcoin exchange-traded product for the last two years that can be accessed by European investors in multiple countries, and the products have attracted more than $1 billion.

Stockholm-based XBT Providers launched its CoinShares series in 2015. The XBT Bitcoin Tracker One (COINXBT) trades in Swedish krona, while the XBT Bitcoin Tracker Euro (COINXBE) — they launched on the Nasdaq Stockholm in 2015. XBT also issued versions in Denmark, Finland, Estonia and Latvia. In the Swedish krona version, 200 shares equal the price of one bitcoin, and in the euro version 20 shares equal the price of one bitcoin.

The big difference between the successful Swedish launch and the impasse in the United States is the type of exchange-traded product: the XBT portfolios are exchange-traded notes (ETN), not exchange-traded funds.

An ETN is an unsecured debt instrument that promises to pay the pattern of returns of the bitcoin price. Ironically, despite being an unsecure instrument, the XBT product tracks the spot price of bitcoin by holding the actual currency and forward contracts in case of a liquidity shortfall.

“At that point in time, the ETN structure was the best route to bring the products to market,” said Laurent Kssis, chief executive officer of XBT Provider. “As a result of using this structure to bring the product to market, investors have been able to gain exposure to the price movement of bitcoin since 2015. This stands opposed to the U.S., where most investors are still waiting for access to bitcoin exposure via their normal brokerage account.”

There are three ways to construct a bitcoin portfolio

There are three different ways in which a firm could create a bitcoin exchange-traded product. It could create an exchange-traded fund that owns and stores actual bitcoins, similar to the SPDR Gold Shares ETF (GLD). GLD tracks the spot price of gold by holding physical gold bricks in bank vaults in London. The second way is a bitcoin futures ETF, which approximates the price of bitcoin by owning bitcoin futures products. That’s been the dominant paradigm for SEC filings, including the ones recently pulled, due to the recent uptick in bitcoin futures contracts offered by major U.S. exchanges and securities firms.

“I think using the ETN structure to launch a bitcoin product was a good fit,” said Arlene Reyes, chief operating officer of Exchangetradedfunds.com, a website that reports on global ETFs. “ETNs are unsecured instruments backed by the credit of the issuer, and it tracks the performance of the underlying asset. … XBT Provider holds bitcoins equal to the value of ETN shares issued and tracks the performance of the price of bitcoin. I can see how this structure would be attractive to regulators.”

“I don’t know why an ETN hasn’t been done yet. We know other people are in discussions to make one, but it’s not us. We know it’s being talked about.” -Garrett Stevens, chief executive officer of Exchange Traded Concepts

This past October, XBT came out with two more ETPs to track the second most highly used cryptocurrency, ether, in both Swedish krona and euros: Ether Tracker One (COINETH) and Ether Tracker euro (COINETHE). These also are listed on the Nasdaq Stockholm for European investors.

One of the ETF companies that filed for a bitcoin ETF has looked at the ETN route and says others have been talking about it as well.

“We have considered notes with regards to bitcoin, but we have not had the opportunity,” said Garrett Stevens, the chief executive officer of Exchange Traded Concepts, which worked with REX ETF on a rejected bitcoin futures fund. “But we are a white-label company and we do what someone else wants. That’s what the REX guys wanted, so that’s what we created. I don’t know why an ETN hasn’t been done yet. We know other people are in discussions to make one, but it’s not us. We know it’s being talked about.”

There is one product that currently gives U.S. investors access to the bitcoin market — the Bitcoin Investment Trust (GBTC), managed by Grayscale Investments. However, GBTC is not an ETF, despite press reports. It’s not SEC-registered, and it trades on the Nasdaq over-the-counter markets. It’s highly volatile and can trade at an extreme premium to the price of bitcoin. Some brokers, including Merrill Lynch, are refusing to sell GBTC and other bitcoin-related securities to their clients.

Because they trade on an exchange, products like ETFs and ETNs are not only priced using a net asset value (NAV) — the value of securities held minus liabilities and divided by shares outstanding — that is calculated at the end of each day and by intraday NAV (iNAV) throughout the day. They also have a current market price, which can be more (a premium) or less (a discount) to actual value. The more volatile a market, the more likely there is to be a premium/discount issue.

“The [XBT] products are very well designed for what they do. They deliver, unlike GBTC,” said Matt Hougan, the chief executive of Inside ETFs, an ETF education company. “They give exposure to the returns of bitcoin and ether pretty well. I think they were well executed and they’ve done their job.”

But Michael Sonnenshein, managing director of Grayscale Investments, remains positive. “We are thrilled about the response of the market to the Bitcoin Investment Trust since it became publicly quoted in 2015,” he said. “My team is looking forward to bringing our second vehicle, the Ethereum Classic Investment Trust, to the OTCQX market in second quarter of 2018.”

Some ETF experts believe the chances remain good for a bitcoin ETF to be approved this year.

Before the crash, ETNs were more popular in the US

ETNs were once among regular exchange-traded product launches in the United States, though never at the level of exchange-traded funds in number of portfolios or assets raised. They were more popular with banks as issuers — which had the existing debt businesses to structure the credit side of the investment — than with standalone asset-management companies.

Before the financial crash, there were dozens of ETNs that covered commodities sectors, and many still exist today. But ETNs became less popular after the financial crash, based on the theoretical risk that a failure like Lehman Brothers could expose ETN investors to severe credit risk. While the theoretical risks did not play out, ETNs waned in popularity among new launches.

At the end of 2008, near the depths of the fiscal crisis, there were 74 ETNs, totaling $3.6 billion in assets under management. By the end of 2017, there were 204 ETNs, with combined assets of $24.9 billion, according to ETF.com

ETF companies that have filed for bitcoin ETFs, including REX, Proshares, Van Eck and Direxion declined to comment. Gemini, the investment company of the Winklevoss twins, did not respond to a request for comment.

Like the U.S.-based GBTC, the XBT bitcoin ETNs typically trade at a premium or discount to the actual price of bitcoin, but the range has been much smaller than in the case of GBTC, between 1 percent and 3 percent.

According to Bloomberg, the 52-week average percent premium is 0.46 percent, but it has been as high as 21 percent and as low as negative 16 percent. Still that’s a far cry from the 65 percent premium seen on GBTC.

“What Laurent has proven is the ETN structure has worked and been able to deliver that pattern of returns that’s different from the two paradigms filed with the SEC, which is the physical and the bitcoin futures products,” Hougan said. He also thinks the premium/discount issue is being handled fairly well in the case of XBT’s bitcoin portfolios.

“Bitcoin is an expensive product to trade, custody, store and service at this point. So I don’t think a 3 percent premium in the ETN is absurd,” he said. “That makes the ETN a viable approach.”

Currently, the two Bitcoin Trackers combined (krona and euro) have total assets of $900.8 million, and the two Ether Trackers have total assets of $439.3 million.

—By Lawrence Carrel, special to CNBC.com

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When Exchange-Traded Notes Trump ETFs

On the surface, exchange-traded notes appear similar to their more popular cousins, exchange-traded funds. Both seek to match some sort of market barometer, and both offer similar advantages over actively managed mutual funds: lower fees, lower investment minimums and greater tax efficiency. And, like stocks, you can trade them throughout the day.

But don’t be misled. ETFs and ETNs are very different animals. ETFs mimic the indexes they track by holding a diversified collection of securities, such as stocks or bonds. ETNs, however, don’t own anything. An ETN is an unsecured debt that is typically issued by an investment bank. Like an ETF, an ETN tracks an index. But when you invest in a note, you’re merely buying a promise from the issuer to pay you the index’s return, minus fees.

So when you buy an ETN, you not only take a chance on whatever index the note seeks to copy, you also assume the risk that the issuer could fail to make good on its promise. Investors in three ETNs sponsored by Lehman Brothers got a taste of that sort of risk after Leh­man went belly up in 2008. So far, none of its creditors, including its ETN investors, has received a penny.

So Why Buy ETNs?

Even with all that extra risk, notes do have some advantages. For starters, ETNs offer access to hard-to-reach asset classes and investment strategies (we’ll discuss some of them later). Moreover, although ETFs are subject to tracking error — that is, the chance that the fund will not move precisely in sync with the index it’s designed to match — ETNs are not.

ETNs are also more tax-friendly than ETFs. ETFs, like mutual funds, must distribute annually to shareholders all the interest and dividends they collect from the securities they hold. Investors who receive these distributions in taxable accounts must share their earnings with the IRS at rates as high as 35%. An ETN, by contrast, reflects the collection of dividends and interest by adjusting its net asset value, so you don’t pay taxes until you sell the ETN. And if you hold an ETN for more than a year, you pay the long-term capital-gains tax rate of 15%.

Commodity-oriented ETNs also have a tax edge over similar exchange-traded products. With a commodity ETN, you pay taxes when you sell, allowing you to pay the favorable capital-gains tax rate if you hold the ETN for more than a year. Most exchange-traded commodity funds invest in futures contracts and are set up as limited partnerships. That means investors have to tackle potentially complex Schedule K1 forms. Moreover, you must pay taxes on any capital gains the ETF realized during the year, even if you didn’t sell any shares. In addition, ETFs that hold precious metals, such as gold, are taxed as collectibles, at a maximum rate of 28%, not 15%. (Currency ETNs don’t have the same advantage as other ETNs; interest from these ETNs is taxed as ordinary income on an annual basis.)

4 ETNs Worth a Look

In each case we list below, the ETN either offers advantages over comparable ETFs or provides a strategy that is unavailable with an ETF.

Commodities. Because of the tax pluses, investors may find Elements Linked to the Rogers International Com­modity Index — Total Return (RJI) the best way to invest in stuff. Issued by the Swedish Export Credit Corp., RJI is the fourth-largest ETN in the U.S., with $919 million in assets. It follows a benchmark of 38 commodities created by Jim Rogers, a commodity expert and author. The index has a 44% weighting in energy, 35% in agricultural products and 21% in precious and base metals. Over the past year, the ETN returned 40.4%, compared with 37.9% for PowerShares DB Commodity Index Tracking Fund (DBC), the largest commodity-oriented ETF (all returns are through June 3). The ETN’s annual expense ratio is 0.75%.

For the full story and other three ETNs, go to Kiplinger.com.

ETF Assets Surge 31% in March

Assets in U.S. listed ETFs and exchange-traded notes (ETNs) continue to hit record levels in March, surging 31% year-over-year to $1.08 trillion, according to the National Stock Market.

ETF/ETN net cash inflows for March totaled $11.2 billion. For the first quarter, cash inflows soared 240% to more than $28.9 billion, compared with $8.5 billion for the same period in 2010. March notional trading volume for ETFs and ETNs totaled approximately $1.8 trillion, representing nearly 31% of all U.S. equity trading volume. At the end of the month, there were 1,173 listed products compared with 971 at the same time last year

To view the full report go to: National Stock Exchange Market Data. NSX also publishes a product-by-product breakdown of the 1,173 products on which the data is based.

Net Cash Inflows Double; Large-Caps Lose, Emerging Markets Win

Net cash inflows into all exchange-traded funds (ETF) and exchange-traded notes (ETN) grew to approximately $17.1 billion in May, doubling April’s total, according to the National Stock Exchange (NSX). Despite the huge inflow overall, ETFs holding large-capitalization indexes such as the S&P 500, Dow Jones Industrial Average and the Russell 1000 posted significant cash outflows. Meanwhile, emerging-market ETFs recorded huge net inflows.

iShares remained the top ETF firm with $290 billion in assets under management. State Street Global Advisors came in second with half that, $142 billion. Vanguard took third at $54 billion. PowerShares’ $31 billion came in fourth and ProShares $26 billion claimed fifth.

The SPDR Trust (SPY) remained the king with $63 billion in assets. SPDR Gold Shares (GLD) came in second with a distant $35 billion.

I noticed a trend of heavy net cash outflows from the large-cap U.S. equity funds. So, even as the market rose in May, the SPDR saw $146 million flow out in May. The PowerShares QQQ (QQQQ), which tracks the Nasdaq 100 and is the sixth-largest ETF, had outflows of $435 million. Meanwhile, $639 million was pulled out of the Dow Diamonds (DIA), which tracks the Dow industrials. Surprisingly, the iShares S&P 500, (IVV) which also tracks the S&P 500 and is the fifth-largest ETF, saw net cash inflows of $441 million. However, all the iShares ETFs that track the Russell 1000 or an offshoot also saw outflows. Does this mean that traders think the U.S. stock market has peaked and have taken profits? I wouldn’t be surprised.

That money appears to be moving into emerging markets. The iShares MSCO-Emerging Markets (EEM) took honors as the third-largest ETF upon receipt of $1 billion in cash inflows in May. The only ETF with more net inflows was the iShares MSCI Brazil (EWZ) with $1.5 billion.

Year-to-date net cash inflows totaled approximately $29.8 billion, led by fixed income, commodity, and short U.S. equity based ETF products, says the NSX. Assets in U.S. listed ETF/ETNs grew 10% sequentially to approximately $594.3 billion at the end of May. The number of listed products totaled 829, compared with 767 listed products a year ago. This data and more can be found in the NSX May 2009 Month-End ETF/ETN Data Report.

ETF/ETN Assets Grew 10%, Inflows 17% of Total

Assets in U.S.-listed exchange-traded funds and exchange-traded notes (ETN) grew 10% in April over the previous month to $540.2 billion, according the National Stock Exchange in Jersey City, N.J. March assets totaled $489.2 billion.

Out of April’s $51 billion increase, 17%, or $8.5 billion was due to net cash inflows. The rest came from price apprecation . The NSX says year-to-date net cash inflows jumped 59% to $12.6 billion, over the same time period in 2008. In February, ETF/ETNs saw net cash outflows of $5.8 billion, but that turned positive in March with net cash inflows of $8.1 billion

At the end of April 2009, the number of listed products totaled 844, compared to 719 one year ago. Notional trading volume for ETF/ETN products totaled $1.6 trillion for April 2009, representing 33% of all U.S. equity trading volume. That fell from March, when notional trading volume was approximately $2 trillion, representing 38% of all U.S. equity trading volume.

Elements to Delist 3 More ETNs

Credit Suisse Securities plans to kill three of its four Elements-branded exchange-traded notes. The firm said last week that due to trading volumes insufficient to support an exchange-traded product, the three ETNs would be delisted from the NYSE Arca by April 3.

The three ETNs, the Elements MLCX Gold Index ETN (GOE), the Elements MLCX Livestock Index ETN (LSO) and the Elements MLCX Precious Metals Plus Index (PMY) may continue to trade on an over-the-counter basis. This might be the first time an exchange-traded product trades this way. If this occurs, the intraday indicative values for the securities will no longer be published, but the daily NAV would be after the closing bell.

Credit Suisse has no plans to delist the fourth ETN, the Elements Credit Suisse Global Warming ETN (GWO).

“However, there is no assurance that the GWO ETNs will continue to be listed on NYSE Arca or another securities exchange,” the statement added. “In addition, from time to time Credit Suisse may decide, at its sole discretion, to issue additional units of the GWO ETNs.”

IndexUniverse reports that the Securities and Exchange Commission had contacted Credit Suisse in late February regarding “extraordinary” trading and price movements linked to GOE. At the same time, Credit Suisse said it didn’t plan on issuing any new shares of the ETN and that there was no lead market maker on the NYSE assigned to make a market for the fund.

Elements is the brand name for a consortium made up of issuers and distributors. In addition to Credit Suisse, Deutsche Bank and Swedish Export Credit have issued under the Elements name. Merrill Lynch and Nuveen Investments are the consortium’s distributors. Five other Elements ETNs have been delisted for lack of assets. In October, nine months after they launched, Deutsch Bank closed five currency ETNs it had issued under the Elements brand.

Survey Finds Nearly Half of Advisors Don’t Do Monthly Reviews

Rydex Investments, the sponsor of leveraged ETFs and the CurrencyShares, exchange-traded products that track foreign currencies, released its Advisor Benchmarketing Supplemental Survey this week. Here are some highlights:

· Most of the advisors (55%) surveyed review the ETF universe and their clients’ ETF holdings monthly.

That may be the majority, but is a little more than half really most advisors? Is this a positive statistic? Well, let’s flip it around. Nearly half (45%) of all advisors DON’T review the ETF universe and their clients’ ETF holdings monthly. So, the odds are nearly 50/50 that your advisor isn’t on top of things. That’s not what I want to hear. Let’s hope your advisor isn’t one of them.

· Open-ended mutual funds and ETFs will be a primary vehicle or product focus for 2009 for investments, according to 98% and 83% of advisors respectively.

That agrees with what I’ve been saying for months. In fact, I think ETFs will surpass mutual funds in the cash inflows for 2009.

· When selecting ETFs for their clients’ portfolios, investment objective and index exposure are the most important criteria, according to 60% of advisors surveyed. The second and third most important decision making criteria are fees (45%) and benchmark tracking accuracy (35%), respectively. It’s interesting to note that more than a third of advisors (38%) do not find Morningstar rankings (or rankings from other research providers) important as decision criteria for ETF investment.

It makes sense that you have to decide what you want before you look at fees. I’m curious to know why so many advisors don’t use the Morningstar rankings.

· Most (80%) of the advisors surveyed said that they are knowledgeable on the differences between ETNs and ETFs, with almost all of them declaring themselves ‘very knowledgeable’ on the tax consequence differences between ETNs and ETFs (97%). Only about a third (30%) are knowledgeable on tracking error differences between the two.

Tracking error is the difference in return between an index fund and the index it follows. This typically results from the costs required to create and hold a portfolio of securities. Index funds should shoot for a tracking error of less than 10 basis points. Since ETNs don’t hold securities, they don’t incur any costs to create or hold a portfolio. They are merely a promise by the issuing bank to pay the return of the index. Thus, a well run ETN should have no tracking error.

· When advisors research different ETF choices, more than half (55%) use the Morningstar ETF center, 40% use the Yahoo! Finance ETF Center and about one third (34%) use ETF provider sites.

For my list of the best sites for researching ETFs check out How to Decide Which ETFs Are Best for You.

· Despite the current economic situation, ETF assets grew to more than $725 billion globally by the end of 2008, according to consulting firm Strategic Insight, and are expected to continue growing in assets over the next few years.

According to the Investment Company Institute, the trade group for the mutual fund and ETF industries, in 2008 U.S. mutual fund assets fell 20% year-over-year to $9.6 trillion, while U.S. ETF assets slid 12.7% to $531.3 billion. I will address the growth in ETF assets in another posting, but that attests to the growth of ETFs outside the U.S.

Amid Turmoil, ETF Firms Bring Out New Funds

Well it seems that even amid the turmoil in the broader market and the closing of funds in the ETF industry, new funds are launched every week. Over the previous two weeks, we’ve seen a new airline ETF from Claymore Securities, State Street Global Advisors and BGI both launching two new bond ETFs and Barclays Bank launching two new exchange-traded notes.

This week, Van Eck Global’s ETF family, the Market Vectors, launched two funds. The Market Vectors High-Yield Municipal Index ETF (HYD) launched today on the NYSE Arca, following on the heels of Tuesday’s launched, the Market Vectors Pre-Refunded Municipal Index ETF (PRB) with an expense ratio of 0.24%

HYD will track the Barclays Capital Municipal Custom High Yield Composite Index. This high yield index is a market-size weighted index comprised of publicly traded municipal bonds covering the high-yield long-term tax-exempt bond market.

Van Eck says PRB is the nation’s first ETF to focus on the pre-refunded segment of the municipal bond market and will track the Barclays Capital Municipal Pre-Refunded—Treasury-Escrowed Index. This market-size weighted index holds publicly traded tax-exempt municipal bonds. The unique part about it is the index is comprised of “pre-refunded and/or escrowed-to-maturity bonds.” Heather Bell of Index Universe describes the bonds this way: “Say a city issues $100 million worth of bonds to fund a water facilities project. A few years ago, the deal came to market with interest payments to investors of 6%. But now, with interest rates for 30-year triple-A munis hovering around 5%, the city decides to cut its costs. So it reissues more bonds at the lower rates covering the exact same project. The municipality then takes the proceeds from that second issue and buys similar-termed Treasuries. Since most munis have call features prior to maturity, the Treasuries are put in an escrow account to fully fund the interest and principal of the munis on their first call dates.”

I will address the new ETNs in a later posting.

Stepping on the brakes

Much like other structured products that came of age during the past decade, the market crash of 2008 was the first serious test of how exchange-traded funds would react in a bear market. But while the surge in issuance has continued in Europe and Asia, growth rates in the US have slowed.

The exchange-traded funds (ETFs) industry outside the US has surged this year, with 253 funds launched by the end of September, a 69% increase on the same period last year and a figure that is already 27% bigger than all ETF issuance in 2007. During the two months to September 30 – one of the worst periods in recent stock market history – 83 ETFs were launched bringing the total to 1,499 funds on 43 exchanges worldwide, while assets under management hit $764.08 billion. Barclays Global Investors expects this figure …

This was originally published in Structured Products. For the full article click here.

ETNs Vs. ETFs

The media has been comparing exchange-traded notes and exchange-traded funds since the first ETN launched in 2006. By now, the outlines of the argument are clear.

ETNs claim to have three big advantages over ETFs: zero tracking error, access to difficult-to-reach markets and greater tax efficiency. Likewise, they come with one major drawback: They are credit instruments and, as such, subject to credit risk.

The reality is that, for most investors and in most situations, the question of which is the better product is moot. The majority of ETNs exist in markets where ETFs do not exist, and vice versa, so weighing issues like tracking error vs. credit risk is pointless. If you want to invest in certain commodities, countries or strategies, ETNs are the only choice.

That is slowly changing as both markets expand, however: ETFs are honing in on territory previously the sole domain of ETNs, while ETNs are intruding on territory formally occupied only by ETFs. And some of the biggest ETNs do compete in areas where ETFs exist. As a result, the question of which is better is becoming very real.

This is made all the more important by the fact that it is often easier and faster for companies to launch ETNs than ETFs. Some wonder if ETN issuers are rushing products into the space just to be the first one out of the box.

“Time to market is always a factor in decision making, so if you could track the same asset in a fund or a note, there could be a competitive advantage to getting it out more quickly with a note,” said Kevin Rich, managing director in Global Markets Investment Products at Deutsche Bank. “From the issuer’s perspective, notes can offer a more expedient process in the way you interact with the regulators on listing, and investors benefit by having [access] to the product sooner. At the end of the day, if a better product comes out, people will vote with their assets.”

“In general, the first-mover advantage is helpful,” said Philippe El-Asmar, managing director of Barclays Bank’s iPath family of ETFs. “But it doesn’t determine success. It matters whether investors want to take the tracking error vs. the credit risk.”

So which should they want?

This story was originally published in ETF Report. For the full article click here.