Pacer Exploits Its Edges

Pacer Financial got into the ETF business—almost by accident—in 2015, and has since built up to a judiciously launched lineup of 20 ETFs with $4.8 billion in assets under management. Its largest fund is the $2.6 billion Pacer Trendpilot U.S. Large Cap ETF (PTLC). Here, ETFR speaks with Sean O’Hara, president of Pacer ETFs, about how a well-known distributor broke into the ETF space and established a multibillion-dollar fund family.

Source: FactSet, data as of 9/9/2019

ETF.com: Why did Pacer get into the ETF space?

Sean O’Hara: Our initial plan was to do what we used to do. My partner Joe Thomson and I have been working together for some 35 years, and the idea initially was that we’d become sort of the hired-gun distribution for somebody who had a product they wanted to get into the market. We went through a number of relationships, from launching RevenueShares with those folks, to helping Royal Bank of Scotland (RBS) with its exchange-traded note platform and the Trendpilot strategies.

And out of all that experience, there was a happy coincidence. In RBS' case, we were having success with them, and then they decided suddenly they didn't want to be in the business anymore. When that happened, we said, “Here's an opportunity for us to become more than just the hired-gun distribution force. We can become the manufacturer and industry leader.”

We didn't set out initially trying to build an ETF company. We just sort of wound up here. I think we're successful—even though we didn't exist five years ago—and we have big growth plans.

If you're smart about it and you have a good plan, people who aren't in the business can actually get in the business today and be successful.

ETF.com: What do you see as the firm's core strengths?

O’Hara: No.1: distribution. No. 2: innovation. No. 3: An underdog's insecurity about competition and wanting to win.

The Trendpilot series is your best-known group of ETFs. What problem are those funds solving for investors?

O'Hara: Essentially, the goal of trend following is to find exit and entry points in the market using a signal. And we use the 200-day simple moving average as our signal. For decades, it's been a reliable way to pick those points.

The problem that Trendpilot solves for investors is that, at some point, the ETF will simply move away from the markets or risk and into T-bills. And the goal is really to not have a catastrophic outcome when you get to a bear market cycle. It's a risk mitigation strategy.

If you own it over a full market cycle—in other words, the bull market and the bear market cycle—we believe you'll make enough on the upside and miss out on enough of the downside where you have a chance at producing excess return versus your benchmark.

ETF.com: What drives your Cash Cows family of ETFs?

O’Hara: Free cash flow yield is the free cash flow a company generates, divided by its enterprise value. And enterprise value is the market cap plus the debt minus cash. You're measuring how much cash I'm receiving in return for the amount of money I'm paying for a company. And the higher that free cash flow yield, the more cash you receive.

The Cash Cows approach is based on a fundamental belief here that companies that generate high free cash flow yield over time will produce higher returns than the broad-based indexes. They tend to be high quality companies. They tend to be companies that pay dividends and grow their dividends. And using free cash flow yield as a metric to screen broad-based indexes tends to steer you away from companies or sectors where they're not generating a lot of free cash flow relative to their market cap plus debt and into companies or sectors that do.

ETF.com: Would you talk about that distribution model a little bit?

O’Hara: We are a heavily wholesaler-based model here. We have 33 external wholesalers. The plan is to move that number up to about 44 by the end of the year.

We break the world into two component parts today: what we would call the member firms (the Merrill, Morgan, Wells, UBS, Raymond James, the big member firms, as an example), and then sort of the rest of the world (which would be your big independent firms, your Ceteras, your Advisor Group, your Cambridge, your Commonwealth). And then in that group, also the pure breakaway RIAs of the world.

And then we do a lot of marketing. We do email marketing, social media. We do a lot of print. We do TV and other media. The bulk of what we do is focused on how do we gather more assets and how do we help people understand more clearly what it is we're trying to do with our ETFs and where they fit in client portfolios and who they're good for and who gets the most benefit out of that.

ETF.com: What kind of barriers to entry did the firm face when it launched its first ETF?
O’Hara: Well, we got lucky in that when RBS decided to exit the ETN [exchange-traded note] business, we were able to acquire a lot of the intellectual property that went with that business and build ETFs off of that intellectual property. The Trendpilot indexes in their original form came from RBS. We tweaked it just a little to make it a little bit better, having been dealing with it for about five years.

We were able to get a quick start with assets because we moved a decent amount of the RBS business. That was a very fortunate occurrence. We’d put a lot of effort into helping RBS get in the business, and so we had the sales force behind that. That was a big advantage for us.

One of the biggest obstacles you face as a newer ETF company is access to distribution. And then we face all of the other things that new ETF companies face, like you don't have a lot of assets to begin with in a product. Even though it's a great idea, people don't want to take a big bet on it, so they might give you a little money and wait for it to get bigger.

Every step of the way, it gets a little bit easier, because you get a little bit bigger in terms of the assets in the firm, which means that advisors can make a little bigger allocation to it or feel comfortable that they can make a little bigger allocation to it. It's a tough business.