For decades, the exchange-traded fund has been synonymous with index-based strategies and issuers competing to see whose fees can go the lowest.
But 2021 appears to be the year of the first-time issuers, advisors and subadvisors fueling a surge in ETFs that go against the mold: high-cost, niche actively managed strategies that are seemingly designed not to draw in the trillions of publicly traded dollars that have made the likes of BlackRock and Vanguard billions in fees.
As of Dec. 8, 41 issuers had filed for their first ETF in 2021, according to an analysis of FactSet data, amounting to just under a quarter of all the issuers on the U.S. market since State Street launched the SPDR S&P 500 ETF Trust (SPY) in 1993.
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The trend is similar for first-time ETF advisors—third-party firms tasked by issuers to manage the investment strategy of a fund—and the subadvisors that are used primarily to leverage experience running niche investment strategies.
Of the 185 firms that have ever advised an ETF, 44 began advising in 2021, and 43 subadvisors started working with ETFs so far this year out of 165 total subadvisors in the industry.
These figures are slightly fuzzy because issuers will sometimes outsource advising and subadvising roles to a subsidiary, but still suggest a watershed interest from small investment firms seeking to branch out from the world of separately managed accounts and mutual funds into the ETF space.
A clear catalyst for these new industry entrants is the “ETF Rule” that was approved by the SEC in 2019. The update to the regulatory framework guiding ETF launches spared issuers from needing to request an exemption from the Investment Company Act and that allowed actively managed funds to use custom baskets like their passive counterparts.
That combination made it far easier for traditional active managers to take proprietary strategies that would normally be housed in a separately managed account or a mutual fund and add the tax and flexibility benefits of an ETF.
ETF Store President Nate Geraci said the combination of the ETF Rule and the emergence of white-label issuers has made the historically cumbersome task of launching an ETF easier, and the growth of demand for the wrapper is impossible to ignore for money managers.
“This year, we're going to hit something like $900 billion in terms of net inflows,” he said. “You can't just sit on the sidelines anymore.”
Kip Meadows, CEO of white-label ETF issuer Nottingham Co., said his firm has received approximately 15 inquiries a month from first-time issuers about launching their own funds this year, far more than in years prior.
Asset managers were generally hesitant to launch their own ETFs until the active and semitransparent fund structures that debuted in 2018 and 2019 showed their mettle, he notes, and momentum toward small, first-time issuers committing to launches ground to a halt early last year as the COVID-19 pandemic shattered economic certainty.
But the early part of 2021’s animal spirits appear to have driven that confidence back into the ETF launch pipeline, especially for firms with a larger amount of assets already under management.
It doesn’t make sense from a fee standpoint to move assets in separately managed accounts into an ETF unless the fund can attract approximately $50 million to $60 million, Meadows says, but that figure is within reach for much of the industry.
“If a firm says they have a pretty sizable client base and has some accounts [from prospective clients] they've turned down that they could’ve accepted if they had an ETF, when they start looking at it, they say it makes sense,” he said. “...It's an easy way for them to manage their business.”
New Kind Of ETF
While the ETF wrapper makes these new funds cheaper to operate from the issuer side, that doesn’t necessarily mean they’re cheaper to buy.
Of the roughly 430 funds launched in 2021 by Dec. 8, nearly 69% of debuting funds charge more than 50 basis points in fees, and 7.9% of new funds charge more than a full percentage point. Those figures were 64% and 2.3%, respectively, in 2020, and just 42% and 5.7%, respectively, in 2019.
Todd Rosenbluth, head of ETF and mutual fund research at CFRA Securities, said these ETFs at their core are meant to be bought by clients of a particular firm as part of a larger suite of services. While nonclients can buy into these funds and contribute to the assets-under-management figure, those assets aren’t of much concern to the fund operator.
“The fee is not being priced in a way to attract net new money,” he said. “They're immune to the fee war that's ongoing within the broader ETF marketplace.”
Open-Market Buyer Beware
In some cases, it might be risky for outside money to get into exchange-traded products designed for one asset manager. Take the Credit Suisse FI Large Cap Growth Enhanced ETN (FLGE), a product designed solely for clients of Fisher Asset Management.
The fund saw an outflow of nearly $1.3 billion on a single day in May 2020, almost certainly due to an internal decision to move assets by Fisher itself.
Courtesy of FactSet
That amounted to nearly 95% of the fund’s assets at the time, and could have spelled trouble for anyone who owned FLGE but wasn’t a Fisher client.
That potential liquidity risk and other risks inherent in a publicly tradable product designed for a small group of investors needs to be part of the due diligence process for prospective buyers, Geraci said:
“I don't think it's something that investors should necessarily be losing sleep over, but it's something they should have on their radar.”
Contact Dan Mika at [email protected], and follow him on Twitter