New Fund Structure Akin To An ETF Incubator

Christian Magoon is the founder of ETF issuer Amplify. He also created the YieldShares High Income ETF (YYY), a fund with $126 million in assets under management (AUM). Last month, Magoon and his firm filed to start a new fund structure that’s essentially a unit investment trust (UIT) that will convert to an ETF once it hits a certain AUM threshold and reaches its one-year anniversary. ETF.com caught up with him at Inside ETFs in Florida to discuss this new idea.

ETF.com: Let's talk about this new ETF structure you filed for. Has the structure been approved by the SEC? Or is this literally a whole new ball of wax?

Christian Magoon: So it's using two existing structures that are approved, which is an index-tracking unit investment trust, not unlike what the PowerShares QQQ Trust (QQQ) or the SPDR S&P 500 ETF Trust (SPY) is built on.

And then on the other side, there’s a traditional index-tracking ETF. The new technology is this conversion trigger that takes an index-tracking UIT and converts it into a traditional ETF. The conversion trigger is what we're applying for exemptive relief for. That's what our patent application is based on.

ETF.com: Why not just launch an ETF?

Magoon: The big advantage for launching what we call our ACES product—Amplify Convertible Equity Securities—is really threefold.

No. 1, seed capital: Instead of needing about $2.5 million to seed an ETF, it's about $150,000 for an ACES product. So, cost advantage on seed. No. 2, operational capital: It's about $250,000 a year to operate an ETF. ACES will be probably about a $50,000 one-time fee to operate the fund. So operating is quite a bit less. And then, the startup costs are probably only about $10,000-15,000 versus a traditional ETF of maybe $80,000.

It will be about 10% of the cost to do an ACES product versus a traditional ETF. And yet you still have an index-tracking investment that's transparent, that has the tax efficiency of an ETF, that'll have a ticker and tracking ability of an ETF. And then it has the option to convert into an ETF if it passes the minor league, so to speak, and gets into the majors.

ETF.com: And is it on an exchange, and how would I buy it?

Magoon: Initially there'll be two ways. You can look at the CUSIP; it'll have a CUSIP. There also will be—and this is an initiative we're working on as well—a three- or four-letter ticker you'll be able to pull up and see pricing.

Unlike an ETF, while it's an incubator, it’ll have end-of-day pricing. That'll be similar to a traditional UIT or a mutual fund. You put an order in and you buy at the end-of-day close while it's an ETF incubator. That's probably the biggest difference.

But as you know, the trading of ETFs—especially new ETFs—causes a lot of consternation in the markets. Not everyone likes that. Not everyone likes or needs the ability to have intraday liquidity. We don't think that's a key feature. We think having the index-tracking ability, being tax efficient, having a transparent portfolio is the big essence. And we'll have that.

ETF.com: So you’ll do the creation/redemption, or how will orders work?

Magoon: A UIT has a trustee that supervises and manages the ETF. Orders will go through them, and they'll create more shares as orders come in at the end of the day. There isn't actually a creation/redemption process while it's a UIT. It's actually simply building or selling units based on demand. Once it converts into a traditional ETF, everything is similar to what we know and love.

ETF.com: So you buy it and then you want to sell it. So then Amplify buys it back? Or is it like a mutual fund?

Magoon: We're going to work with existing UIT companies that have the ability to sponsor. In our first filing, we’re working with Elkhorn. Someone will place an order to buy or sell that Elkhorn-sponsored UIT, and then the transaction will happen through Elkhorn and the trustee, which is Bank of New York.

ETF.com: Has there been any other product like this before?

Magoon: No, there hasn't.

ETF.com: How do you get an advisor to buy this, since it's such an unusual and different structure?

Magoon: In total, there hasn't been a product like this before, but at the front end, there are products like this. There are index-based UITs and there are obviously traditional ETFs.

So it's really trying to get the advisor to buy the process. We don't think it'll be that difficult, because for somebody who's buying traditional UITs, this will look and act, smell, feel like a traditional UIT, except it won't have a static portfolio; it'll rebalance with the index. For somebody who buys an ETF, this will be a little bit different because it won't be trading intraday. But it'll still have all the characteristics of an ETF.

ETF.com: In this particular filing you've just done, this is a fund of funds?

Magoon: That specific one is; that's correct. It's one portfolio. It's an index that essentially does some rotation among different ETFs based on some macro indicators. All the products that we do in this ACES format have to be index-based, and we could do maybe as many as 30 in the next 12 months once the first one rolls out.

Again, these are index-tracking products that we think have the potential to become an ETF, but they're going to have to qualify. The prospectus of these products will have language in there that says there's a certain AUM and/or time period the product has to achieve.

We think of it as maybe $50 million to $100 million, and being in the marketplace a year. We think there'll be other uses for this. We've already heard some groups say, “We're concerned about getting seed capital. We want to launch a suite of four ETFs, index tracking, but we can't get four $2.5 million seeds, $10 million of seed capital on day one.” We can take the timing of our launch back into our own hands, and we can get the seed capital, which is hard to come by.

ETF.com: Will your future products be both ETFs and under this new structure product? Or are you looking at this new structure as a way to really launch ETFs in the future?

Magoon: Anything that’s a traditional index-based ETF will be hard not to launch as an ACES product. The economics of that product are a lot more favorable. We’ll still be launching other products that will probably be in the ETF wrapper. We just filed for this oil price-hedged MLP product. That doesn't fit in a traditional index ETF. It's actively managed. There are some futures involved in it.

Some things won’t fit in the ACES structure. But in the foreseeable future, I think most of our index-based ETFs—if not all of them—will be launching in that ACES structure.

ETF.com: And have you had any interest from other potential users of this in terms of issuers?

Magoon: We've had interest expressed at the exchange level, at the issuer level, at the market-maker level, and we just announced it publicly. This has really been under the radar. Many companies want to be in the ETF business, but when they learn about the economics or they deal with the reality of seed capital, it becomes intimidating for them. When you can incubate an ETF for 10% of the cost of a traditional ETF, people's eyebrows get raised and they get interested.

There's going to be a healthy appetite. This solves a lot of problems potentially for ETF investors with zombie ETFs, with closure rates going up. I think having a minor league, so to speak, or a qualification before something becomes an ETF helps market makers, in not having to put up all the seed capital, which is tough for them to do. From an issuer perspective, it's very hard to subsidize these funds over long periods of time if they're not breakeven.

This could potentially really innovate and add a lot of value to the ecosystem around even exchanges. A lot of exchanges have issuers lining up to launch products, but they can't get the seed capital.