Differentiation Key For Rising Small ETF Issuers

Differentiation Key For Rising Small ETF Issuers

Staking out territory in ETFs when all the low-hanging fruit is gone.

Reviewed by: Gerrard Cowan
Edited by: Gerrard Cowan

[This article appears in our June 2021 issue of ETF Report.]

There’s a wide range of smaller issuers in the ETF market, many focused on particular niches or pursuing innovative strategies. While it can be challenging to compete with the giants of the funds world, such firms can offer investors a welcome means of diversification.

Although there’s no rule of thumb for defining a smaller issuer, here we focus on firms with assets under management (AUM) of below $5 billion as of April 26, 2021. By way of contrast, the largest brand—BlackRock’s iShares—had AUM of more than $2.2 trillion.

Smaller issuers focus on a wide range of areas and deploy an array of strategies, both passive and active. They’re popular with investors for a number of reasons.

They can be nimble and proactive in identifying the “potential next investment trend,” says Todd Rosenbluth, director of ETF and mutual fund research at CFRA. And they can devote all of their resources and focus toward the research that supports that theme, “because they’re dedicated to it,” he adds.

Differentiation Is Key
It can be a tough market for smaller players, because “we’re swinging with big gorillas—the biggest players on Wall Street,” said Paul Dellaquila, president of Defiance ETFs, which has AUM of just over $1.4 billion across a range of funds, such as the Defiance Next Gen Connectivity ETF (FIVG). He notes that the trick is to establish just how you can stand out.

Defiance ETFs aims to complement the core positions in an investor’s portfolio, representing perhaps 1-10% of their holdings, by building precision instruments that focus on unique ideas. These have to be conveyed in the clearest way possible, even down to the ticker, Dellaquila says, particularly when marketed toward retail investors.

“We’re trying to make it very simple, saying ‘This is what you’re getting; if you believe in it like we do, then invest. If not, there are thousands of other ETFs out there,’” Dellaquila added.

Amplify ETFs has AUM of more than $4.75 billion, offering ETFs in everything from cannabis to online retail. CEO Christian Magoon says the firm has often sought to import strategies from other areas—like separately managed accounts—into the ETF domain.

It’s important to “blaze new ground,” says Magoon, so that “you’re not bringing the 25th version of large cap growth or large cap value; you’re bringing something entirely different.”

This can take time and demand educational efforts for both retail investors and advisers, he notes, but is worth the effort in the long run, both for those investors and for the firms involved.

Getting Attention
Generating awareness can be a challenge, however, in a crowded marketplace featuring dozens of other issuers, says Magoon.

While his own firm is now in the top fifth of issuers by AUM, it can still be tough to attract attention, “especially relative to the large sponsors, where there’s so much concentration of assets” and which can spend millions of dollars annually in branding and marketing. Still, Magoon believes issuers like Amplify can prosper by offering carefully curated diversification to investors—what he calls “a craft brewer, artisanal strategy.”

The concentration among the top three to four ETF issuers is in many ways a “glass half full” scenario for smaller issuers like Aptus Capital Advisors, says founder and managing member JD Gardner, as it means “the ETF space is ripe for fragmentation.”

Aptus operates four actively managed ETFs, with a combined AUM of about $1.2 billion: the Aptus Defined Risk ETF (DRSK), Aptus Drawdown Managed Equity ETF (ADME), Aptus Collared Income Opportunity ETF (ACIO) and Opus Small Cap Value Plus ETF (OSCV).

Such fragmentation will be driven by issuers that take advantage of many of the existing and new opportunities offered by the ETF wrapper, Gardner says, from tax efficiency to the new “ETF Rule,” which eliminated the time-consuming and costly “exemptive relief” requirement for most ETFs.


Small Issuers To Watch
Issuer/Brand# Of ETFsAUMLargest ETF
Amplify Investments11$4.8BAmplify Online Retail ETF (IBUY), $1.5B
Aptus Capital Advisors4$1.2BAptus Defined Risk ETF (DRSK), $656.4M
Defiance ETFs5$1.4BDefiance Next Gen Connectivity ETF (FIVG), $1.2B
Merlyn.AI4$290.9MMerlyn.AI SectorSurfer Momentum ETF (DUDE), $171.7M
ProcureAM1$131.9MProcure Space ETF (UFO), $131.9M

Source: FactSet, 5/5/2021


Unique Approaches
Many smaller issuers emphasize unique technical approaches to their offerings. For example, Merlyn.AI deploys signal processing and AI-powered algorithms to analyze ETFs across various segments of the U.S. market, building portfolios that seek to achieve key investor goals, according to the firm.

Those goals include a portfolio of momentum leaders in bull markets, and defensive leaders in bear markets; an automated, proprietary method for switching between these portfolios; the advantages of tactical trading combined with the tax efficiency of the ETF wrapper; and automated execution.

Lisa Noble, Merlyn.AI’s vice president for marketing and communications, says the aim is to build appeal for a range of investors, notably investment advisors, as the automated approach “allows them to spend more time communicating with clients and the other things that an advisor needs to do to build their business.” 

Regulation & Costs
Merlyn.AI ETFs had AUM of about $290 million as of April 26, 2021. Valery Talma, the firm’s CEO, says industry regulation can pose challenges for smaller issuers, demanding investment in compliance, lawyers and communications.

“There are a number of very large, very significant players in this industry,” Talma said. “To make your way up that ladder requires a distinctive technological advantage and a lot of human and financial resources.”

Some smaller, newer ETF issuers seek to combine their fund issuance with other work, providing a means of diversification, and often generating new ideas for their ETF business. ProcureAM, for example, operates the Procure Space ETF (UFO), and has AUM of about $134 million.

However, it is also part of the wider Procure Holdings. Andrew Chanin—founder and CEO of both entities—says that Procure Holdings has a number of subsidiaries. For example, it provides consulting work for other parties that may wish to enter the ETF marketplace.

“We’ve set ourselves up to work with many diverse partners and help them grow their businesses, as well bringing our ideas forward,” he said.

Track Record Matters
For investors who might be considering investing with a smaller issuer, the most important thing—where possible—is to look at the sponsor’s track record regarding their launching and closing of new funds, says Ben Johnson, director of passive funds at Morningstar.

He points to three major considerations. First, that the theme is “real and durable.” Second, that the fund is investing in the right stocks, which have an appropriate level of exposure to the theme. And third, that the valuation is right—sometimes a fund might launch when a theme is already well-established in the marketplace, squeezing the potential gains.

“For some funds and the investors in them, the payouts have been quite large—the problem is that many fail to survive,” Johnson added. “The thematic funds graveyard is pretty crowded.”

Gerrard Cowan is a freelance journalist who writes on finance and technology. He previously worked at The Wall Street Journal, where he edited the Business & Finance section of the European edition, and at Jane's Defence Weekly. Gerrard is the author of “The Machinery” fantasy novels, published by HarperCollins.