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In the eyes of many regulators, exchange-traded funds (ETFs) are seen as interlopers in the investment world. ETFs have been the subject of studies and speeches blaming them for all forms of market distortions, malfunctions and outright crashes. But there are signs that the ice is melting and that regulators are slowly but surely warming up to ETFs. It started a few weeks ago when the Government of China approved the launch of two yuan-denominated ETFs tracking Hong Kong stocks as a way to let mainland investors trade shares in the former British colony for the first time in history.

Now, closer to home, the U.S. Securities and Exchange Commission (SEC) finally approved the use of derivatives for active ETFs, which rely on manager skill to outperform rather than just passively tracking an underlying index. The news came in a speech by Norm Champ, the SEC’s director of the investment management division. Champ was clear there would still be tight restrictions on derivatives, stating firmly that the SEC isn’t changing its position in regard to leveraged and inverse ETFs.

All the same, it’s good news for the ETF industry and puts it on a more level playing field with active fund managers who’ve used derivatives for years. Most notably, star bond manager Bill Gross, co-chief investment officer with PIMCO, has used them in his fixed income fund, the Total Return Fund, one of the largest mutual funds in the world. PIMCO has also had tremendous success by launching an ETF version of the flagship fund, which has not been able to rely on derivatives in tracking the fund. Interestingly, the PIMCO Total Return ETF (BOND) has returned 12% since inception, compared with 7.4% for Gross’s mutual fund.

With derivatives back on the table for at least some ETF providers, this could open up the space for active ETFs to grow and for new players to enter the market. And, at the very least, it shows that ETFs are gaining a bit more acceptance in the eyes of the policy-makers and regulators.

Caroline Cakebread is editor of Canadian Investment Review and based in Toronto.
© Copyright 2014 Rogers Publishing Ltd. Originally published on benefitscanada.com

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