Another year, another list of new ETF launches. In 2017 we saw over 270 ETF launches.
Although new ETFs are seemingly launching daily at this pace, there is a lot more that goes into the process behind the scenes than there might seem.
If you are one of those individuals or firms looking to join this growing market segment, ask yourself these questions before jumping in with both feet. After all, you don’t want to be a statistic. In 2017, 138 ETFs closed down.
1. How does a strong market affect a launch? What if the market enters into a correction?
Timing is everything, but if you can predict the direction and timing of market swings you should be a futures trader, not opening an ETF.
Trees do not grow to the sky. At a certain point, the market will turn.
The last major market correction, and one of the scariest in history, occurred in 2008. Looking back, any fund of any type launching in July 2008 had very poor timing. There was a flight to quality government bonds and other supposedly safe instruments, and many mutual funds and hedge funds folded. Eight months later, however, in the spring of 2009 was the start of the current bull market. So if you had a fund that was new, with no negative track record from 2008 and before, and were ready to accept assets when investors were ready to take advantage of low prices, you were in a great position.
If you’re considering launching an ETF, don’t let a potential market pullback stop you! History shows that when markets correct, astute investors recognize the value and buy in. When the markets correct, be prepared with a marketing narrative to promote your product to intelligent investors who will understand the importance of buying assets at a discount.
Regardless of where the markets are when you launch, be prepared to power through and encourage existing and potential investors to do the same. Long-term investors are rewarded for their patience and avoidance of knee-jerk reactions. If you have a good idea and a solid plan, there is no time like the present to launch.
2. Have current clients asked about ETFs?
In today’s world of non-stop news and 24/7 access to financial data, investors have their ideas and opinions. If your client base or potential client base has asked whether you plan to launch an ETF, this is an excellent barometer for potential demand.
Funds are an ideal vehicle to consolidate your smaller accounts that are difficult to properly diversify or administer from a client relations standpoint on a standalone basis. It is likely that you could pool these investors together into your new ETF. For these clients especially, try to gauge their interest in advance of your launch. Get indications of potential interest, and then assume 50 percent of them will have some reason not to pull the trigger in the early stages, just to be safe.
3. In terms of timing, where does your new ETF fit into your firm’s business plan?
A new ETF doesn’t go from idea to the trading floor overnight. A de novo exemptive application can take the better part of two years or more for the legal process to get approved. A way to avoid that deferral of getting a good idea to market is to partner with a white-label firm that has the experience and legal and political know-how to deal with the SEC and issues that will inevitably arise. Because of the structure and how a series trust works, this will shorten the process to four to six months.
Whatever the lead time, you need to ensure you are both being realistic with your timetable, and factoring enough room into your business plan.
4. Do you have the connections and relationship to start an ETF on your own? Have you thought about vendor and service provider relationships?
There is no substitute for relationships. The best vendors are not looking to enter into a large number of relationships – they prefer to focus their efforts on a smaller number of more meaningful relationships.
When it comes to launching any investment product, and perhaps especially an ETF, relationships are your lifeline. Attorneys, auditors, custodians, exchanges, market-makers, APs – the list goes on. Do you have standing relationships with these parties that you can rely on? If not, consider partnering with a white-label firm who does. This will not only make things easier, but faster.
5. Do you have $20-30 million of early stage demand to make an ETF economically viable?
The harsh reality is that, regardless of how groundbreaking or successful your strategy is, assets under management (AUM) is what really matters.
Many wirehouse platforms have AUM restrictions. Gatekeepers and consultants look at AUM and may have thresholds below which they will not even consider offering your product.
The expense ratio of your ETF is critical to marketing and competitive success. The expense ratio is the total accrual for expense that is paid for by the fund. Any expenses over and above that accrual are paid for by the advisor or subadvisor backing the ETF. If the assets are not there to cover the expenses with that accrual, it can be a very expensive proposition.
If you know you have a significant demand, then you may be in a position to project a lower expense ratio accrual, which is more attractive in the marketplace. As a general rule of thumb, if you cannot see a clear path to at least $30 million, you should probably consider another business plan or an enjoyable expensive hobby.
Launching a new ETF is a major undertaking and commitment. Most good things are though, so do not let the prospect of pushing and working hard scare you off. As long as your plan is sound and your relationships are strong, you can be on the road to success in no time.