10 Most Important People In ETFs

March 11, 2015

[This article first appeared in the March 2015 issue of the ETF Report.]

Tim Clift, chief investment strategist at Envestnet, finds himself at one the more dynamic spots in financial markets. Here, the ubiquitous hand of technology is changing the way investors invest, the way traders trade and even the way advisors help clients.

Tim Clift

The company—among other services—provides the open architecture that allows more than 100 fund strategists to market their ETF model portfolios to investors everywhere using tools such as unified management accounts (UMAs).

UMAs allow investors to aggregate various strategies into one comprehensive statement, and firms like Envestnet market those various strategies in one place. It's not the only firm in its space, but these days, if you're not on Envestnet, you're sort of nowhere.

Clift is a gatekeeper of sorts, advising ETF strategists—especially ones just starting out—how to run their portfolios more smoothly, and, not least, offering them a platform where they can market their various strategies.

More than $600 billion in assets is tied to Envestnet in an "assets under administration" arrangement, with a total of about 2.8 million client accounts. Envestnet also has about $65 billion in discretionary assets under management, and $18 billion in proprietary assets in a relatively new portfolio management operation, the latter of which Clift is involved with closely.

To be clear, the company includes mutual funds as well as ETFs on its platform, but make no mistake: ETFs are increasingly where the action is. More specifically, the ETF strategist space has been one of the fastest-growing pieces of the $2 trillion ETF world in the past few years.

"The majority of the growth has been in ETFs," Clift said. Whether it's for tactical trading or for more strategic holdings, "ETFs are much more suitable for trading," he added. "I'd say ETFs have a very bright future. Innovation is still in the early stages."

After a brief stint in the early 1990s at Donaldson, Lufkin & Jenrette, where he pitched stocks and wasn't "feeling it," Clift joined and helped build a firm called FundQuest, a technology-driven company that was mining the same trading-technology traffic that Envestnet would one day join and come to dominate.

Envestnet was born in 1999, and it ended up acquiring FundQuest in 2005. Clift quickly gained influence and stature in the new company, and he says his inclination to push for different ways of doing things is perhaps his best quality as a manager, and probably helped propel his career.

"I push every day to think of new ideas, and I'm assembling a team that can do that," he noted.

Indexing matters. Just ask Henry Fernandez.

Henry Fernandez

"As index providers, we live in exciting times," says the chairman and CEO of MSCI, the world's second-largest index provider. "Now more than ever, we have the wind at our backs."

For almost two decades, Fernandez has helmed MSCI, transforming it from a niche cost-center within Morgan Stanley into one of the world's premier indexing giants. Under his leadership, MSCI has become synonymous with quality in indexing, particularly for global equity benchmarks.

"I truly believe we're only on the ground floor of what's possible to achieve," he said, adding with a laugh, "And I'm not just saying that because I work here."

Today more than 675 ETFs track MSCI benchmarks, or more than track the benchmarks of any other provider. Together these funds comprised $373 billion in assets as of year-end 2014, according to MSCI data. Interest has especially surged among institutional investors, says Fernandez. MSCI-linked ETFs are now the favored choice of many of the world's largest institutions, including pension funds, sovereign wealth funds and hedge funds.

"The institutional community likes having access to those deep, liquid ETF markets, and having more flexibility in their investment process," said Fernandez. "Today's institutional investors are thinking more acutely about what they're investing in. They don't want to give carte blanche to their asset managers anymore."

MSCI continues to provide some of the most innovative indexes in ETFs, particularly when it comes to factor-based indexes, which are sometimes lumped in with "smart beta" indexes.

ETF creators, driven by institutional interest, have embraced MSCI's take on factors. Of the 95 ETFs launched last year tracking MSCI indexes, 42—or almost half—tracked MSCI Factor Indexes, compared with just six ETFs in 2013.

"There's a bit of a revolution right now in factor investing," said Fernandez. "But what we see now is not new. It's an acceleration of the existing trend, driven by lower costs, greater access to data and better index engineering."

While the trend may not be new, the way people think about it is: "Instead of focusing on traditional factors—such as countries, large/small-cap, or value and growth—investors now want us to look at modern factors as well, such as momentum and liquidity," he added.

The role of the index provider is changing, adds Fernandez. Gone are the days when an indexer was expected to simply represent the markets.

"Investors want index providers to give them not just an opportunity set, but a portfolio, an investment strategy," said Fernandez.

Commission-free ETF platforms have been around for some time, offered by firms such as Vanguard, TD Ameritrade and Fidelity. They've opened up the world of ETFs to the retail investor in a major way. Investment advisors and individual investors can trade funds for almost no cost whatsoever, eliminating one of the more expensive aspects of ETF investing.

Heather Fischer

But perhaps no firm has distinguished itself in this area as much as Charles Schwab, with its OneSource ETF platform, led by Schwab Vice President Heather Fischer.

Fischer joined Schwab in 2006 from Bain, and took her place at the head of the OneSource ETF platform at the start of January 2014, roughly a year after Schwab rolled out the commission-free trading program. According to her, the key factors differentiating Schwab's OneSource platform are simplicity, sustainability and selection.

By simplicity, she means that the program has "no catches," as in no enrollment and no short-term redemption fees. "What you see is what you get," Fischer said.

And by sustainable, she means the OneSource platform is no promotional offer or gimmick; it's something that's here to stay.

"This is something we're committed to for our clients. They've told us that commission-free ETF investing is important to them. We've designed it so we can be in it for the long haul," Fischer explained.

She noted that, in a recent Schwab survey, 64% of investors said the total cost of an ETF is their No. 1 concern, and 85% said commission-free trading is important to them.

But it's selection where Schwab really stands out. The platform has grown to encompass nearly 200 funds from more than a dozen issuers, including Schwab's family of more than 20 core asset-class ETFs. Not only is it the largest and most comprehensive commission-free ETF platform in terms of range of funds offered—covering 64 Morningstar asset categories—it also has more than $38 billion in invested assets.

"We really have a nice wide selection to help all kinds of investors build that diversified commission-free ETF portfolio," Fischer said.

And indeed, investors seem to be responding. Schwab saw $10 billion in inflows to the ETF OneSource platform in 2014 alone. Put another way, 43% of ETF inflows via Schwab's brokerage went into commission-free offerings; those offerings represent just a small percentage of the more than 1,600 available U.S.-listed ETFs, and don't even include popular industry behemoths like the SPDR S&P 500 (SPY | A-98) or the iShares MSCI EAFE ETF (EFA | A-91).

One of the biggest growth stories in ETFs is a firm that has been a behind-the-scenes player in ETFs from the start, but that has only in the last year or so stepped into the view of the mainstream.

Todd Hollander

Jane Street is a relatively small firm but it's also a big deal. On any given day, it can trade more than $8 billion in equities and can execute more than 1 million trades. That's in one day.

But the real heart of the story these days is its ETF trading business, where Todd Hollander is a senior member of the ETF sales & trading team. Jane Street was founded in 1999, and from the start engaged in providing ETF liquidity and other arbitrage-related businesses. Hollander worked as one of its traders operating on the exchange floor, joining the firm in 2001.

But Hollander's involvement with ETFs actually began long before he came to Jane Street—he's been trading ETFs since 1993. "The first day that SPY traded in 1993 on the floor of the AMEX, I was there in the trading crowd," he noted.

Jane Street soon saw there was a particular demand for liquidity in the harder-to-trade ETFs. Today the firm has 60 traders at its three offices trading ETFs.

"Over time, as Jane Street realized this was a niche for us, we started to concentrate on it and build it out," Hollander said. Jane Street is a registered market maker for every one of the 1,600-plus U.S.-listed ETFs, and has additional offices in London and Hong Kong.

"We turned trading ETFs into a global business, which is something that we feel differentiates us in the sense that we offer ETF trading across the globe," Hollander added.

For roughly 15 years, Jane Street has traditionally offered liquidity on-exchange as well as provided block pricing to banks and brokers. In early 2014 it added a client-facing business that delivers liquidity directly to institutional clients, Hollander says.

"Up until last year, we never faced clients directly. It was always done through third parties, including banks and brokers. Clients can benefit from accessing our liquidity directly now, which is something that has changed our business dramatically," Hollander said.

Perhaps most importantly, Jane Street provides capital commitment for block trades from its own balance sheet. The firm's traders understand risk, Hollander notes. That's something that no doubt helps them do their jobs effectively.

Martha King is an optimist, but one who's a big believer in the power of negative thinking.

Martha King

She says that's it's only by anticipating what could go wrong that you can prepare yourself to overcome obstacles in order to achieve your goals. Positive thinking just kills motivation.

That guiding principle infuses everything she does, and has helped her propel Vanguard's Financial Advisor Services (FAS) unit into a $1-trillion-in-assets business. Today FAS not only represents about a third of the company's total assets, but it's also Vanguard's fastest-growing unit, snagging about half of the firm's asset growth in 2014. Consider that a short 10 years ago, FAS was in its infancy, with only about $180 billion.

You could argue King has done the most to bring better and cheaper products into the hands of financial advisors—and ultimately investors—everywhere during her 15-year tenure at the helm of the unit. Her success largely hinges on Vanguard's laser focus on costs and on investor outcomes, a focus that applies to its mutual funds but is increasingly centered on ETFs.

King joined Vanguard's institutional unit right out of college some 30 years ago, but about 15 years ago, she was asked to get a new business unit running that would be calling on financial advisors.

"The reason was quite clear to us: Things were changing in the financial advisory community in the U.S.," King told us. "There was a growing acceptance of, and interest in, fee-based solutions."

"We saw broker-dealer firms and other firms that did commission-based businesses start to form capabilities to let their brokers become financial advisors in these fee-based practices. It was a door-opener for Vanguard," she said.

The trend was a perfect fit for Vanguard, which had never had a payment-for-distribution program. Because of that, the mutual fund provider wouldn't have been calling on these brokers, but in a fee-based world, they could. That opportunity happened to coincide with the launch of Vanguard's first ETF, the Vanguard Total Stock Market (VTI | A-100).

"Why did we do it? Vanguard was a leader in index mutual funds, so for us, ETFs represented both an opportunity and potentially a threat," King said. "Our leadership in traditional index mutual funds was quite clear, but what if ETFs were going to take over? We wanted to make sure we were prepared for either eventuality."

"The fortunate convergence of these events happening was that ETFs were a far better way for us to start opening doors with financial advisors when we began to do so 15 years ago," she said.

Jim Ross can teach us a little something about perseverance, if not about impeccable timing.

James Ross

More than 22 years in the ETF business, Ross was there when the SPDR S&P 500 ETF (SPY | A-99) first came to market, joining the team that helped the American Stock Exchange (Amex)—then a client of State Street—just a few months before the first-ever ETF in the world made its humble debut. Talk about timing.

It all began when he joined State Street in the summer of 1992, taking a job known as "fund administration" involving compliance and financial reporting of mutual funds. As he puts it, it wasn't "the most exciting job" because that business group was new, and, truthfully, not all that busy.

That's when opportunity came knocking. Ross was asked to help with SPY two months before launch.

"State Street at the time was the asset manager on SPY, so it did things like index rebalance, and all servicing," Ross said of the early days. "We saw the Amex as our client. This wasn't a business for us. We were in the servicing of ETFs."

Fast-forward to the early 2000s: State Street decided to be in the business of ETFs, and Ross was one of the first people to join the team. State Street's "phase 2.0" was underway.

The next several years saw the expansion of the product lineup and the creation of a small distribution network, but all without a clear branding message.

In 2004, came another milestone: the partnership with the World Gold Council and the birth of a blockbuster, the SPDR Gold Trust (GLD | A-100). Welcome to State Street's "phase 3.0."

"GLD was a huge success, but with that came the concern on how to rebrand," Ross says. "We had to decide who we wanted to be when we grew up."

Over the next few years, the firm went on to rebrand all products to be a cohesive lineup of ETFs, and it also entered the international arena for the first time both in the equity and in the fixed-income segments.

The company is now embarking on "phase 4.0," launching some 20 ETFs in 2014 and increasing marketing and distribution.

"I love the fact that everyone pays the same price in an ETF and has the ability to use the same product," Ross said. "The ETF structure treats all shareholders equally, and it helps to build well-constructed portfolios. That's the nirvana of this business."

Positioned at the center of WisdomTree—the only pure-play publicly traded ETF company—is its founder and Chief Executive Officer Jonathan Steinberg, who built his $2.5 billion company around two insights that were both way ahead of their time.

Jonathan Steinberg

The first is that the future belonged to cheap, transparent and highly liquid ETFs; the second is that the future of index investing was in what has come to be called "smart beta."

"We needed to be innovators," Steinberg said in a recent interview, stressing that he saw no reason to replicate the pure-beta index funds championed 40 years ago by Vanguard. Indeed, Steinberg's firm has been a pioneer of fundamentally weighted indexing, which—in the case of WisdomTree—has meant constructing funds that weight securities by dividend and earnings streams instead of by price.

WisdomTree also creates its own indexes, putting it at the very start of another ETF industry trend; namely, self-indexing. Its stock price has more than tripled in the past two years—again a reflection of WisdomTree's success and the growing popularity of ETFs themselves.

"The ETF is the new force, and I have aligned all of my interests on what I believe to be the future," Steinberg noted. WisdomTree is now the No. 5 ETF firm by assets and total money invested in U.S. ETFs, which, as an industry, has more than $2 trillion after investors plowed almost $250 billion into ETFs last year.

So, things are definitely coming together for WisdomTree. In fact, it's behind the two most successful ETFs of the past few years: the WisdomTree Europe Hedged Equity Fund (HEDJ | B-51) and the WisdomTree Japan Hedged Equity Fund (DXJ | B-57). HEDJ is sucking in assets like a vacuum and is now a nearly $10 billion fund. For its part, DXJ, ETF.com's "ETF of the Year" in 2013, now has almost $13 billion in assets.

Both products protect U.S. investors from the weakening of the yen and the euro and, moreover, both have indexes that tilt to exporting firms that are likely to reap the benefits of a weakening currency.

WisdomTree by now has a reputation for spotting trends before they go parabolic—"smart beta," self-indexing and currency hedging, to name the most obvious examples. Steinberg projects a certain humility about it all, saying that if he does have one noteworthy gift, it's surrounding himself with major-league talent.

"It's pretty much an "All-Star" team at WisdomTree, and I couldn't do any of this without them," Steinberg said.

When it comes to the future of ETF product development, as well as maintaining the status quo, certainly no other regulatory body is more important to the ETF industry than the Securities and Exchange Commission.

Mary Jo White

In turn, there is no more important regulatory leader for the ETF industry than SEC Commissioner Mary Jo White when it comes to being the industry gatekeeper.

Front and center for the SEC is whether it will approve what many see as the next big leg up in ETF expansion: nontransparent, active ETFs.

The playing field for nontransparent active ETFs has already begun to take shape, with Eaton Vance's "ETMF" structure approved by the SEC in November, although there's no update on when the first funds using their structure might launch. However, when it comes to nontransparent, active management in an ETF wrapper, the door remains closed.

The most recent development saw Precidian Investment's filing for nontransparent, active ETFs get rejected in October by the SEC. In December, the firm refiled with some significant changes that seem tailor-made to address SEC concerns about the nontransparent, active structure.

If the new Precidian filing is sufficient to address the SEC's previous concerns, that will be good news to a significant portion of the industry: To date, BlackRock, State Street, Invesco PowerShares, Cohen & Steers and American Funds are all waiting in the wings, having licensed the Precidian intellectual property for its future active ETF filings.

As for now, White's SEC team has given no indication of when it will decide. In fact, a common theme in many of White's public speeches has focused on transparency. "Transparency is one of the primary tools used by investors to protect their own interests," she said in a speech last June in New York.

White has also expressed concerns about illiquid assets like bank loans in ETFs as well as mutual funds, which could potentially lead to a clampdown on those products.

In addition, the SEC began this year working on a white paper about the extent to which ETFs "exacerbate financial volatility," which will primarily cover leveraged and synthetic ETFs. The SEC is also expected this year to approve or reject the proposal for a bitcoin ETF.

With the U.S. ETF industry topping $2 trillion in assets in its 22nd year of existence, the industry is now maturing and looking for new growth and products. No one is more critical for what will and won't be allowed than SEC Commissioner Mary Jo White.

The rollout in October 2012 of iShares' "Core" lineup of products stands as a great strategic pivot that enhanced its ETFs' growing reputation as the great democratizers in the world of investments. In one gesture, the world's biggest ETF company hit the "reset" button and set out on a new trajectory.

Mark Wiedman

The executive behind that move was Mark Wiedman, global head of iShares, the largest ETF issuer in the world. He stresses that the "Core" initiative was generally misunderstood at the time of its unveiling. Many saw it solely as a measure designed to finally give iShares bragging rights that it was offering ultra-cheap ETFs. He insists it was a lot more.

For Wiedman, the "Core" epiphany occurred around the iShares MSCI Emerging Markets (EEM | B-97). The story goes like this: Yes, EEM's status as the world's biggest emerging market ETF was toppled in January 2011 when the significantly cheaper Vanguard FTSE Emerging Markets ETF (VWO | C-82) earned that mantle. But through that changing of the guard, EEM continued to haul in assets.

To Wiedman and his entourage—notably, Ruth Weiss, the iShares executive who heads the "Core" effort—that meant EEM's users were different from VWO's. They were and are often institutions; are certainly more tactical than the retail buy-and-hold crowd that has historically favored Vanguard's VWO; and are essentially unconcerned that EEM costs more than four times as much as VWO.

"The ETF industry is not a monolith—the uses of ETFs are many, and the kinds of clients that use ETFs are many," Wiedman said. "That's the fundamental insight of the 'Core' series, which we've now expanded to Canada and Europe."

Wiedman said the "Core" lineup is, at its root, a cheap offering for the growing numbers of investors—retail and institutional—who embrace the buy-and-hold-and-rebalance mentality. That insight spawned some of the cheapest-available ETFs—including EEM's cousin, the now-$6.2 billion iShares Core MSCI Emerging Markets ETF (IEMG | A-99).

In broadest terms, the company is now looking at product development through this lens of understanding that clients have varying needs. Wiedman tells ETF Report the company is planning a number of rollouts this year that reflect this very granular way to approach new products.

"Once we arrived at that insight, we said: 'Now we know where to go from here,'" he noted. "There are different product segments and there are different client segments, and we just need to organize around that."

The rise of robo advisors—or automated investment services, if you prefer—is one of the defining and important themes of 2015.

Automated Advisor

These firms, including Wealthfront, Betterment and others, use the power of Web technology and ETFs to deliver institutional-quality portfolios to investors at low costs.

How low?

Wealthfront, the market leader, builds well diversified portfolios for clients that are designed by investing legend Burton Malkiel to sit precisely on the so-called efficient frontier—the place where decades of academic research suggest you get the most return for a given level of risk.

These automated advisory services tailor portfolios to each investor's risk tolerance, and offer different portfolios for taxable and nontaxable accounts, with free trading, rebalancing, tax-loss harvesting and custodial service. All of this is tied into a nice bow and with typical fees of $0 on the first $5,000 and 0.25% for all assets above that.

Compare that with the 1-2% fee charged by most financial advisors, and you can see why these firms are disruptive, and attracting assets, particularly from millennials.

So far, asset growth at the robos has been fast … but small.

Wealthfront leads all firms, with close to $2 billion, and the numbers fall off from there. But robo advisors are backed by some of the smartest and most ambitious venture capital money in the world. Wealthfront alone raised more than $100 million in venture capital money in the past year from firms like Index Ventures, Ribbit Capital and Greylock Partners. The firm has said it expects to grow its assets by tenfold every few years.

Driving home the point, larger firms are joining the race quickly. Charles Schwab is expected to launch its own robo-advisory business in the first quarter of 2015, and Vanguard already has a "bionic" advisory service in place that pairs online offerings with access to human advisors by phone.

ETFs changed the game by making institutional-quality products available to all investors at extraordinarily low costs. These new robo advisors do the exact same thing for asset allocation services.

The financial industry will never be the same.

 

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