New ETF Kids On The Block

November 27, 2018

[This article appears in our December 2018 issue of ETF Report.]

 

New ETF issuers are a little like late '90s boy bands: Every year, new ones come and gobut mostly go.

Only a handful of would-be superstars achieve lasting success, for reasons that aren’t always clear to we mere mortals, and for every ‘N Sync, there’s a dozen O-Towns or Dream Streets that never catch a break.

But every year, like clockwork, a new crop of contenders line up, and 2018 has proven no different. Though fewer newcomers entered the ETF industry this year, the ones that did were notable: The Motley Fool, Prudential Financial—even energy billionaire T. Boone Pickens. We even saw the ETF industry’s first nonprofit issuer.

Like the boy-band boom, 2018 has been many things—but boring wasn’t one of them.

Notable List Of Newcomers
As of Oct. 31, 14 new issuers, as defined by Factset, had entered the ETF industry in 2018. Some were mutual fund issuers looking to make a splash in the ETF world. Others were boutique shops courting thematic investors with a unique vision. The funds from those issuers that launched in 2018 are listed in Figure 1.

 

 

Perusing the list of issuers, a few common themes emerge, including: 

Distribution Needed
By now, it shouldn’t be surprising that the vast majority of ETFs from new issuers that launched this year—23 of 25—have yet to cross $100 million in assets under management, the psychological barrier separating the “successful” ETFs from the flops.

That’s because it’s not enough anymore to launch with a few million dollars’ worth of seed capital and a prayer. To attract investment dollars, ETF issuers have to launch with a clear distribution plan in mind—and preferably a built-in client base.

That’s probably why the only two ETFs to hit $100 million—the Motley Fool 100 Index ETF (TMFC) and the PGIM Ultra Short Bond ETF (PULS)—were products issued by big-name asset managers. PGIM is the rebranded investment arm of life insurance giant Prudential Financial, while Motley Fool Asset Management is the fund company associated with the Motley Fool financial media empire, which has been a household name for decades.

Both Prudential and Motley Fool already have billions of dollars in existing client assets, giving them a built-in distribution channel for their new ETFs. This strategy of “BYOA” (bring your own assets), a term coined by Bloomberg’s Eric Balchunas, has been used to great impact by other ETF issuers in 2018.

For example, J.P. Morgan funneled billions of assets into its expanded BetaBuilder ETF suite starting this past summer, ending up with some of the fastest-growing ETFs of all time.

Meanwhile, it’s gotten tougher and tougher for newcomers without that built-in user base to break into the ETF scene. Even massive name recognition doesn’t always translate into assets.

Market-Cap Weighting Passé
When all is said and done, we might remember 2018 as the year that market-cap weighting died.

2018 gave birth to quant-driven ETFs and actively managed funds; ETFs that used artificial intelligence to pick stocks and multifactor ETFs—and plenty of thematic ETFs and smart-beta plays.

But among the funds launched by the new issuers, there wasn’t a single plain-vanilla, broad-based, market-capitalization-weighted index ETF in the bunch! The closest we came was Motley Fool’s TMFC, which weights by market cap but selects stocks based on ratings from Motley Fool research newsletters.

Intriguingly, the most common weighting scheme the newcomers used was equal weighting, followed by fundamental weighting. This suggests newer issuers aren’t necessarily trapped in the same modes of thinking as veteran issuers; instead, newcomers think about portfolio exposure in a more democratized way, where big companies shouldn’t necessarily dominate a portfolio just because they’re big.

Even if smart beta as an ETF zeitgeist has somewhat faltered, it’s clear the philosophy underpinning the movement—that big doesn’t always mean better—continues to shape product design.

Pendulum Swings To Active-Lite
Another major trend in the launches from new issuers was active management—or “active-lite” strategies, where portfolio securities weren’t technically selected at the discretion of an active manager, but they might as well have been for how complicated the underlying methodology is. 

Some ETFs deploy sophisticated smart-beta models, such as the Volshares Large Cap ETF (VSL), which tracks an equal-weighted, rebalanced weekly basket of U.S. large-cap stocks determined through statistical analysis to exhibit the highest probabilities of short-term appreciation.

Others use derivatives contracts to enact institutional strategies. The U.S. Equity Ex-Dividend Fund-Series 2027 (XDIV), for example, goes long in S&P 500 futures while selling S&P 500 dividends futures to gain exposure to the pure price return of the S&P 500 Index. KNG, meanwhile, applies an options-based buy-write strategy on a dividend-focused portfolio to generate additional income.

What Fee War?
In 2018, we continued to see costs drop across the investment industry; Fidelity even launched its own zero-fee mutual funds in the fall. But apparently nobody told the ETF class of 2018 to keep it cheap. The average expense ratio launched by a new issuer in 2018 was 0.59%, or 56 basis points more expensive than the least expensive equity ETFs.

In part, that high cost is likely because the methodology underpinning these ETFs is so complicated. It’s one thing to offer a passive, S&P 500 ETF for 0.03%. But an ETF like MSUS, an AI-driven ETF that offers anywhere from 0% to 160% long exposure on the market, will inherently have higher turnover, and in turn, higher costs.

Still, even as most ETFs launched by newcomers carried high price tags, some issuers tried to constrain costs. PGIM, for example, launched the market’s cheapest actively managed ultra-short-term bond ETF, PULS. Meanwhile, the American Century Diversified Municipal Bond ETF (TAXF) matched the cost of the cheapest active, broad market muni ETF on the market, the Hartford Municipal Opportunities ETF (HMOP).

Still Room For Surprises
You’d think after 25 years we might have seen it all in the ETF space, but 2018 offered a few eye-poppers.

That includes Impact Shares, the industry’s first nonprofit ETF issuer. In 2018, Impact Shares debuted three unique ESG ETFs, of which, 100% of the proceeds will go to support the associated charities and causes, including gender diversity, racial equality and sustainable development.

We also saw the launch of an unusual energy equity ETF from billionaire and noted renewable energy advocate T. Boone Pickens via issuer TriLine Index Solutions. But the NYSE Pickens Oil Response ETF (BOON) has nothing to do with clean power; instead, the ETF tracks companies that have exhibited a high correlation to the price of Brent crude oil over the past five years.

That puts BOON in the unique position of being an energy equity ETF that has less than half its portfolio in energy companies; industrials, basic materials and consumer cyclicals all make up substantial portions of the portfolio too.

So what does the future hold? We can’t know, of course. But we can be confident there’s still room for surprises—and new superstars—ahead. 

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