The Business Of Seeding ETFs

April 02, 2018

No ETF can come to market without seed capital, but finding that money is increasingly difficult in a market faced with fewer and fewer players willing to pony-up capital. Dallas-based Esposito Securities has found a niche in the business of seeding and supporting new ETFs. Among the company’s most recent seeds are funds like the AI Powered Equity ETF (AIEQ) and the NYSE Pickens Oil Response ETF (BOON). Mark Esposito, founder and CEO of Esposito Securities, offers a look at what the business of supporting new ETFs looks like today.

ETF.com: You are an ETF capital provider. You seed new ETFs. Give us a flavor of what this side of the ETF business is like.

Mark Esposito: We started 11 years ago. We've been delivering specialty, customized products and services to all asset managers, and with the proliferation of ETFs, the ETF market has been a big focal area for us. One of the reasons we’re known as a thought leader in the ETF space is because of our seeding capabilities.

It really picked up steam about 18 months ago, when a lot of big players that had seeded ETFs pulled back their balance sheets. We were getting a lot of calls and we said, “Hey, this is a way for us to help the issuer community and shareholders by seeding new issues.” It’s what we call Esposito Seed.

In the last 12 months, we've seeded something like 15 ETFs. We seed new ETFs and we’re involved in the secondary market for ETF products, making tight spreads, and assisting RIAs with block trades.

ETF.com: How do you decide which ETF to seed?

Esposito: For us, it's about the product first. If we don't like the product, there's no reason to be involved with it. Second, it’s whether we want to build on or start a new relationship with that issuer. We've got a 25-point grid that we look at, and we have a team that decides which products to seed. There are many factors that go into it.

ETF.com: How many ETFs have you seeded so far in your career?

Esposito: I'd say over 50.

ETF.com: Any interesting anecdotes about the worst seed decision you ever made, or the best?

Esposito: Well, what's interesting about your question is, no one ever knows prior to launch how a seed's going to go. Sometimes the best products turn out the worst. One recent example of a good seed is AIEQ; it's already a $140 million fund, and it’s just a few months old.

What’s unique about us is the way we handle seed and trading. We get out of the seed fast because we work well in the ecosystem. We keep a really tight spread. The concern about holding on to the seed forever really isn't there for us. We usually get out of the seed twice as fast as most of our competitors. We worry more about building relationships, and our seed is just a step into that.

ETF.com: How does the process of getting out of the seed work so well for you? How long does it take on average for your firm to get its money back?

Esposito: It's taken us between one day and six months. On average, it’s about 30 days to get out. The way it works is we sell shares on the open market, so one of our goals is to find buyers who want to acquire the shares and be long-term holders.

We’ll go out onto the open market and aggressively look for that. It works because that increases the volume, it tightens the spread, the issuer wins, the shareholder wins. And now you've got natural owners of the stock that can help grow the fund.

ETF.com: We almost never hear anymore of ETFs coming to market with $50 million or $100 million. Why is it getting harder to find seed money?

Esposito: It's the proliferation of new issuers and the uncertainty of building a quality, long-term relationship. Also, a lot of the banks have pulled back their balance sheets and they just don't use their capital seed anymore, partially due to Dodd-Frank and partially due to business decisions. There are other places they can put their capital to work that’d probably yield a higher return. That's what we've been told, and that's what we see. We just don’t see new players coming into the space anymore.

ETF.com: Is the minimum viable seed $2.5 million? Is that the industry standard?

Esposito: Generally, you have to have 100,000 shares. But over the past 12 months, people have been bringing some ETFs to market at $15 a share; $20-25 is kind of the gold standard. That’s $2.5 million, and that's where that number comes from. But because seed is so limited, people have to go down to $20 or $15. That's just market conditions; it's hard to get seed capital.

ETF.com: Is the environment for launching ETFs different today than it was, say, 11 years ago, when you started Esposito?

Esposito: Fifteen years ago, there were just a few banks that were seeding, and they were seeding with $50 million or $100 million. We couldn't compete in that environment. We're a small midtier player. We provided a lot of other different services at the time. But a lot of people have left that market, and it's caused a void.

Anyone who has $250,000 can start an ETF. But how do you distribute, how do you grow your product, and how do you get name recognition, and how do you market and do PR? That's the real tough part.

ETF.com: Is the cost of supporting an ETF getting higher, be it from a capital provider or a market making perspective?

Esposito: Yes, the costs are high. But I don't know that they're getting higher. People have started to figure out there might be a better use of capital, and that's why several market-making firms have given back their listings. It's really expensive—the human capital you need and the financial capital you need. Where does the profit come from? It's just an expensive proposition, particularly in the market making side.

Contact Cinthia Murphy at [email protected]

Find your next ETF

CLEAR FILTER