According to government shutdown rules, SEC personnel fall into the “non-essential” category. ETF issuers probably disagree.

The SEC stopped processing ETF filings last week when the government shut down, halting the approval process of dozens of dual-share-class exemption applications. The shutdown has also put certain crypto products, including those holding Solana, XRP and others, on hold. Still, EDGAR — the SEC’s database for submitting all company forms, including ETF applications and rule changes — remains fully functional, and experts don’t expect the shutdown will slow the tide of filings.

“We anticipate filings to continue to build up, especially given current market conditions,” said Grant Engelbart, an investment strategist at Carson Group. “The government shutdown has seemed to do nothing to slow down the recent surge in animal spirits we have seen across risk assets, including cryptocurrency.”

Sorry, We Are Closed

The shutdown comes at a particularly strange time, slowing SEC operations down just as they were picking up speed. Last week, the agency issued a long-awaited update regarding Dimensional Fund Advisors’ request for dual-share-class exemptions, indicating that approval is probably just around the corner. Now, however, nearly 100 such applications are on pause, said Alex Morris, CEO of F/m Investments, which also has pending filings. While Morris estimates that one in five such applications are “serious,” with the rest being “FOMO filers,” all issuers can do now is wait.

The agency does have staff available to deal with emergency requests, but standard filings and exemptive relief filings — including dual-share-class relief — are on hold until the shutdown is done, Morris added. The SEC will be working under its lapse operations plan, a spokesperson told The Daily Upside.

The shutdown, however, doesn’t seem to have dampened issuers’ or investors’ appetite:

• There were 14 new ETF filings in October as of Friday, despite the shutdown starting on Wednesday, according to AdvizorPro data.
• Litecoin — whose new ETF, Canary Capital’s Litecoin ETF, has been delayed due to the shutdown — continued to climb higher last week, its price rising 13%.

Spotted. The shutdown also comes shortly after the agency adopted generic listings standards for spot crypto products, keeping issuers from having to file for a rule change every time and shortening the approval timeline from 240 days to just a couple of months. The change in timelines, combined with the halted processing of new applications, creates uncertainty about approval timelines, said Roxanna Islam, VettaFi’s head of sector and industry research. “There was some progress that was supposed to be made this week, but obviously, there’s not going to be any new ETFs approved right now,” Islam said. “It’s a little bit up in the air.”

My, oh my. State Street is adding high-yield bond ETFs to its MyIncome bond ladder fund suite.

The firm is prepping five target-maturity exchange-traded funds, according to paperwork recently filed with the Securities and Exchange Commission. It’s a small product category with only iShares and Invesco having high-yield target-maturity ETFs on the market. The kicker is that State Street’s forthcoming ETFs will be actively managed, adding to a product line that debuted last year, including corporate and municipal bond ETFs with maturities ranging from 2026 to 2035.

That product set is intended to build bond ladders that “regardless of the market environment or the direction of interest rates, can potentially help build more reliable income streams,” State Street’s chief business officer Anna Paglia said at the time.

Rung by Rung

State Street rolled out its 16-fund MyIncome series last year, and the products collectively represent about $217 million. The pending addition of the target-maturity high-yield ETFs comes as asset managers have shown more interest in the riskier bond category. Vanguard, for example, added its first actively managed high-yield ETF last month, a fund that differs significantly from a comparable mutual fund strategy in its line. However, it’s also not an ideal time for high-yield bonds. “High yield ETFs may appear appealing, but right now the spreads say something else,” said Charles Urquhart, founder of Fixed Income Resources. “BBB bonds are priced almost as if they were AAAs, and high-yield trades close to the tightest levels in decades. That’s not a recipe for being paid to take risk.”

There are two families of target-maturity high-yield ETFs on the market, according to Morningstar Direct data:

• The $3.5 billion Invesco BulletShares high-yield series includes ETFs with maturities ranging from 2025 to 2033.
• The $2.5 billion iShares iBonds Term High-Yield and Income series has ETFs with maturities from 2025 to 2032.

Where Interest Is Climbing: Though high-yield spreads are tight, target-maturity is helpful, said Timothy Calkins, co-chief investment officer at Nottingham Advisors Asset Management. “Target maturity ETFs are helpful when trying to capture some performance from rolling down the yield curve, or trying to match up portfolio cash flows with expected future withdrawals,” he said. The product category also lets advisors mimic bond ladders without having to build them with individual securities, Urquhart said. “[C]lients can watch real maturities roll down, get principal back on time and have reinvestment flexibility,” he said. “It’s a handy tool in a market where trading individual bonds is still difficult for most advisors.”

It’s getting tough out there for the little guys.

Small-cap stocks have started to lose some of their performance zing compared with large caps. The reason: Private equity and venture capital firms have been snapping up many promising small companies that otherwise would likely have gone public, wresting those potentially lucrative opportunities away from public investors. Over the past two years there has been a widening gap in quality between large-cap and small-cap stocks, according to a recent Morningstar analysis. That includes returns on assets, returns on equity, net margin and debt-to-capital ratios showing that overall, small-cap stocks have increasingly weaker fundamentals compared with large caps, Morningstar passive strategies analyst Zachary Evens said.

It’s not hard to find examples of once-startups that have rocketed to become massive companies that would be right at home next to the Magnificent Seven, if they ever had IPOs: OpenAI, SpaceX and Anthropic, for example, Evens noted. “Increasingly, tomorrow’s huge stocks are already big,” he wrote. And if the trend continues, “tomorrow’s big stocks never exist as a small-cap public company.”

Great Expectations

The tradeoff for the higher volatility of small caps is the potential for outperformance. But the prospects for that have been eroding quickly. Between 1991 and 2024, Morningstar’s US Small Cap Index lagged the US Large Cap Index by 0.49% per year on average, amounting to a 400% lag cumulatively. Still, small caps as a whole outperformed large caps from the mid ‘90s until about 2014, when the relative growth of the small cap index began to slide.

In a recent whitepaper, Osterweis Capital Management cited opportunities for small-cap active managers:

• Between 1994 and 2024, small-cap managers showed roughly a 57% median alpha compared with their funds’ benchmarks, while mid-cap and large-cap managers had negative alpha of about 15% each.
• It’s an inefficient market, with just six analysts per small-cap stock on average, compared with 17 per mid cap and 30 per large cap.
• For eight of the past 10 years, a higher percentage of small-cap managers than large-cap managers has beaten benchmarks.

Let’s Go Out in Public: It could be a time for active managers to really show their worth. They’re just going to have a difficult time doing so, Evens noted. “It provides opportunities for the best small-cap managers, but it doesn’t change the opportunity set from which they are picking stocks,” he said. “Even the best active managers may not have the opportunity to invest in the highest growth potential small-cap stocks, if those remain in private markets.”