Launching An ETF Is No Cheap Endeavor

October 17, 2016

Considering how much ETFs are heralded for their low fees, and how many ETFs get launched every year, it’s almost surprising how expensive it is to bring a new ETF to market.

There are myriad steps that go into launching an ETF, and there are just as many costs and fees associated with the process. To get a sense of how much you’d have to spend if you were to put your great investment idea into an ETF wrapper, we talked to a few industry sources who have brought many funds to market over the years, and who are still innovating in the space.

Here are some of the estimated costs of launching and managing an ETF they shared with us, based on their experience and industry knowledge:

Registration Cost: $100,000 to $500,000

The range in the registration process cost has to do with the complexity of the product you are bringing to market.

The SEC has what’s called “generic” relief for certain categories such as plain-vanilla, large-cap U.S. equity ETFs, and seeking exemptive relied for these nonsophisticated, simpler strategies could cost $100,000 or perhaps even a little bit less.

But if you deviate from vanilla, it could take as much as $500,000, and a lot more time to get through the process because it would demand more from regulators and attorneys. Time is money here.

There’s no getting around this initial cost unless you are a big firm and acquire a smaller firm that already has exemptive relief. And here’s why, as we’ve covered before:

“Technically, an ETF is an investment company registered with the U.S. Securities and Exchange Commission, because it holds a portfolio of securities and continuously issues and redeems its shares at daily NAV, just like an open-end fund (commonly known as a "mutual fund"). As we have just seen, however, many institutional and all retail investors do not acquire or redeem their shares directly at the NAV from the ETF provider, but instead buy and sell them at their market prices on the secondary market, similar to the way in which shares of closed-end funds are bought and sold. This hybrid structure, consisting of mutual fund and closed-end fund elements, does not fit into the existing regulatory regime governing investment companies. Therefore, each ETF must request and receive from the SEC formal exemptive, interpretive, no-action and other relief from certain provisions of applicable federal securities laws before it can be brought to market. For regulatory purposes, without this relief, each ETF's structure and operations would be illegal.”

 

Cost Of Licensing An Index

Licensing an index is not expensive, particularly in the early days of an ETF when total assets under management (AUM) are still small. According to industry sources, plain-vanilla U.S. equity ETFs often face 0.03-0.04% of total assets to license their underlying benchmarks. Specialized indexes can cost more, but paying 0.10% a year of AUM for an index is rare.

The index is not a big cost if you are starting out, and have, say, a $10 million ETF. At 0.03%, that’s only $3,000 a year. But as the fund grows, that licensing cost grows too. If you have a $10 billion fund, 0.03% is going to mean $3 million a year. Fees are variable depending on the index provider.

There’s always the option of self-indexing, in which case you don’t have to pay an index provider for your benchmark, but there are other costs associated with putting your index together and managing it.

Seeding The ETF: $2.5M Minimum

So you have a great idea, and you have your exemptive relief. But now you need seed capital. There seems to be no universal rule about minimums to launch an ETF, but you’d be hard-pressed to find a fund that listed with less than $2.5 million as seed. That’s the generally accepted bottom, and that number is usually set by service providers such as custodians who may have minimum requirements in order to get the fund operating properly.

In practice, it would be very hard to launch an ETF with less than $2.5 million because it would be hard to run a portfolio with that little cash—hard to buy a lot of positions. It’s just not very much to work with.

Listing Costs Varying By Exchange

At NYSE Arca, there’s no initial ETF listing fee for most “generic” ETFs following a change in the exchange’s schedule of fees this past summer. Funds such as commodity-based trusts and nongeneric strategies can face as much as a $10,000 listing fee if they are actively managed; up to $7,500 if they are passive. Once listed, ETFs face an annual listing “maintenance fee” that ranges from $5,000 to $40,000 based on the number of shares outstanding and depending on whether the fund is passive or active.

The listing fee at Nasdaq is a one-time fee of  $5,000 for ETFs, which includes a $1,000 non-refundable application fee. Nasdaq caps fees at $14,500 per issuer no matter the number of ETFs listed. 

At Bats, which owns ETF.com, there’s no fee to list on the exchange.

 

Crucial Marketing Costs Also Vary

In the ETF world, there are no 12b-1 fees for marketing, as is the case with mutual funds. For that reason, the cost of marketing is often the cost no one considers when they plan their first ETF.

But the mistake most make is just that—forgetting that important expense. As one source put it, “Many people launch ETFs with the idea that if you build it, they will come.”

But the reality is that getting people to know about your ETF is tricky. Your ETF is not going to find its own audience just by function of being listed. You will have to spend something to get the word out. And as the number of ETFs grow, marketing costs will only grow as you try to cut through the clutter.

What It Costs To Keep A Fund Running

In operational costs alone, you are looking at as much as $200,000 a year depending on the size of the board required to oversee the fund, the lawyers, the administrative cost, etc. This is money that’s going to be used just to deal with governance and the background aspects of an ETF. Think of it as the cost to keep the fund operating legally.

Custodians then take their share—often basis points—to manage the actual portfolio and all the activity that goes into an ETF. Add that to any index licensing and other ETF-portfolio specific costs, and you have another $100,000 or so a year in maintenance costs. The more complex the strategy, the more this can cost.

After your ETF is listed and running, you could expect to spend anywhere from $250,000 to $500,000 a year for one single ETF.

How The Math Work For Sustainability

Consider the math. Say you launched a smart-beta ETF that carries a 0.50% expense ratio. For your ETF to be viable, you would need at least $50 million in AUM just to break even, if your annual costs are at the low end of $250,000. At those levels, with $50 million in AUM, you are merely going to cover your costs.

If you launch 10 ETFs, and your board is already in place and can tackle various funds, spreading out the operational costs, $50 million may no longer be your breakeven point. It may be lower thanks to the benefits of economies of scale. But even for very large providers, it’s hard to run a $20 million or $30 million ETF.

And attracting that kind of asset base may be more difficult than you might think. Out of the 1,900-plus ETFs listed in the U.S. today, roughly 500 are considered at high risk of closure due to lack of enough assets, according to FactSet data. They all have under $30 million in assets, and the vast majority, in fact, have under $20 million in assets. Some are in the hundreds of thousands of dollars.

As Eddy Elfenbein, founder of Crossing Wall Street and portfolio manager of the AdvisorShares Focused Equity ETF (CWS), recently told the Wall Street Journal, “I always complain about the fees for ETFs and mutual funds. But when you are on the other end of the process creating a fund—with so many fees, lawyer fees, exchange fees, etc.—the question is, how can we get them so low?”

Contact Cinthia Murphy at [email protected]

Editor's note: We originally reported incorrectly on some of the listing fees. That information has been updated. We regret the error. 

 

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