How outsourcing can support the successful launch of a new ETF business

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Dave Shashtri, Truss Edge

By Dave Shastri (pictured), Chief Strategist, TrussEdge – The growth in the size of the global ETF market remains spectacular. The volumes flowing into ETFs, including active ETFs, have many fund managers wondering whether now might be the time to look at launching one of their own.

Active and thematic ETFs are ballooning in size and offering the potential for an alternative distribution channel for much smaller fund managers than might have traditionally considered an entry into the market. 

Many fund managers may be deterred, however, by a number of factors, including a lack of operational expertise in the ETF ecosystem, the transparency required on fees and the portfolio. For hedge fund managers, the open-ended nature of an ETF is a big jump. But it is possible for traditional mutual fund managers and hedge fund managers to achieve what they need to in the ETF space by leveraging the experience of established outsourcing partners. 

Specialists with existing track records supporting ETF launches can be invaluable, be it in overcoming regulatory and structuring issues, index creation, distribution or day to day operations. 

Most fund managers are familiar with the idea of outsourcing their fund administration. However, when it comes to the day-to-day management of the ETF itself, things such as portfolio management, operations and trading are also now being commoditised and outsourced. Under such a model, the fund manager is able to quickly launch its own branded ETFs and focus its efforts largely on brand building and distribution whilst leveraging the operational expertise and established infrastructure of the external partner to overcome and troubleshoot all of the ETF-specific hurdles. 

The degree of outsourcing can vary though and it is possible to utilise a lot of a manager’s existing infrastructure and limit the items that are outsourced to a number of critical operational areas, including the ETF-specific bolt-ons that a traditional manager may not already be familiar, among them (but not limited to) intra-day compliance and risk on the portfolio, the production of real-time indicative NAVs and the distribution of the ETF’s portfolio composition file to market makers. 

The more active your strategy, the more day-to-day data management will be required from partners. They will need to have the systems and connectivity in place to seamlessly manage your interactions with authorised participants and market makers. A good way of doing this is via a dashboard of functions that can be used to oversee all the mission critical areas that the fund manager is ultimately responsible for. 

Service providers will be able to provide the new ETF launch with varying degrees of support, but it is helpful to use providers who have considerable experience of launching and supporting successful ETF businesses in the past, particularly in operational areas. The earlier such expertise is brought into the process, the better, as it is important to identify as early as possible any gaps needing to be filled in order for your proposed investment strategy to meet the transparency and liquidity requirements demanded by the ETF wrapper.  

Some key questions that need to be asked at an early stage include: 

Does an ETF make sense for your firm, in the context of your wider business? 

Is the product likely to be in demand from investors, either immediately or in the future, and is your firm currently positioned appropriately to achieve this? 

What else needs to be put in place to take your business from where it is now to building and supporting an ETF business? 

Ultimately, you don’t know what you don’t know: with the best will in the world, unless your firm already has considerable in-house ETF expertise, you will be required to embrace a whole set of new activities with an ETF launch that you will not be familiar with. It is easy to miss something. 

Drilling down into the important role of ETF operations a bit more, these can end up costing a lot of money and lead to the considerable delay of an ETF launch, if attempted internally using entirely existing infrastructure. Daily ETF operations are not like those of the classic open-ended fund.  To support the distribution strategy outlined above, a new ETF manager needs to provide the market maker with data that they can easily use. This should involve new file formats like Portfolio Composition Files (PCFs), indicative NAVs (iNAVs) and negotiated baskets (subscriptions and redemptions in-kind rather than with cash). 

All of these formats and concepts need to be managed on an intra-day basis, and while it might be technically possible to do this with legacy systems together with spreadsheets, this approach can lead to much higher operational costs, especially if there is poor automation within your internal processes. Inefficiencies and errors can easily creep in. Specialist outsourcing partners can manage most of this, operating where needed alongside a fund manager’s existing middle office and complementing those processes seamlessly.  Running the operations of an ETF business demands effective control with cost-efficiency where fine margins can make all the difference.  Unless operational costs are well managed in the ETF, the fund manager will be financially squeezed within the published ETF’s Total Expense Ratio.   

Ultimately when developing an ETF business, success can be in the form of focusing on the key attributes the manager brings and using outsourcing partners to arrange the other pieces of the puzzle.   

Entry to the ETF market can become prohibitively costly and time consuming when poorly executed. If experienced service partners are selected to assist with this, firstly you can be assured that you will get your ETFs off the ground (many have tried and failed to ever launch) and, secondly, you will get them off the ground in a timely manner. And speed to market is everything in this booming, yet competitive, market.   

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