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The dynamic growth and variety of Exchange-traded funds (ETFs) are playing an ever-increasing role in investors’ portfolios and asset managers’ product offerings. Behind the scenes of this growing market are many structural and operational nuances that make ETFs substantially different than mainstream mutual funds. Fund sponsors and RIAs deciding on whether to launch ETF products have many variables to consider.
To explore this further, we reached out to Institute member Michael Prendergast, Senior Vice President, ETF Senior Product Specialist at Ultimus Fund Solutions - a leading independent, tech-enabled provider of full-service fund administration, accounting, and investor solutions which recently announced its industry-leading growth in the ETF market. Recording nearly a 150% increase in the number of ETFs serviced since 2020, Ultimus is now positioned as the second largest named ETF administrator in the US based on the number of ETF sponsors it supports.
We asked Michael questions to tap into his knowledge and insights that can help asset managers and RIAs analyze the opportunities available and understand the dynamics of the ETF marketplace. As the ETF industry continues to evolve, it is important to understand the structural differences, regulations, and distribution landscape for launching an ETF product.
Hortz: What do you feel is behind the increasing demand you are seeing from new and established investment managers looking to expand their portfolio offerings into ETFs?
Prendergast: Investors have flocked to ETFs with flows outpacing mutual funds. The ability to trade an ETF during market hours, typically being a lower cost investment vehicle, and having greater tax efficiency are drivers for investors. The rise in actively managed ETFs has attracted a variety of asset managers to enter the space ranging from established mutual fund sponsors looking to expand their offerings also to RIAs that manage strategies in SMA accounts who want to offer their strategy in an ETF wrapper. This creates operational efficiencies for their advisory firm and a more tax efficient investment for their clients. Given the changes in investment flows, established managers want to have an ETF offering for their clients as their investment habits and preferences change, while at the same time fund sponsors are taking advantage of a new distribution channel for their investment strategies.
With the passage of 6c11, the path to launching an ETF became more streamlined, no longer requiring exemptive relief for most ETF structures and allowing advisors to come to market quicker and incurring less start-up costs. Filing under 6c11 has also leveled the playing field where all ETFs are following consistent rules for reporting and the ability to use custom baskets.
At about the same time as the new 6c-11 rules were approved, the SEC also approved various semi-transparent/non-transparent structures. Many active managers had been waiting for this relief to launch their products. Investment advisors now have expanded options for launching an ETF. Interestingly, we are seeing advisors who wanted to go into the non-transparent space are getting their feet wet with a transparent structure first with thoughts that they may add a non-transparent or semi-transparent product later.
Hortz: What are the costs and timeframe to launch ETFs?
Prendergast: The registration process is now typically the same time-to-market as launching a mutual fund. Once you have an established trust or participate in a series trust like Ultimus sponsors, your time to market typically is 100 -130 days. This incorporates drafting and filing of the prospectus and related filings with the SEC, as well as operational readiness and required connections to the ETF ecosystem with the fund sponsor, your ETF vendors, and service partners. If you are starting out and establishing your own stand-alone trust this can take 6-9 months.
Start-up costs associated with an ETF within a series trust are typically $40,000 - $60,000. If you are starting your own trust, it can be anywhere from $150,000 - $300,000, depending upon legal fees and start-up board costs. Ultimus has significant assets under administration and scale within our series trust environment which allows a new sponsor to leverage our institutional governance, fund efficiencies, and share certain trust level expenses of this structure with other sponsors within the trust.
Hortz: How did you build your service model and capabilities to provide fund sponsors with comprehensive solutions across the entire ETF ecosystem?
Prendergast: We have a service model that provides optionality and flexibility. We created a flexible operating model that will suit each client’s business needs – offering a wide range of efficient and cost-effective solutions.
As an example, we have had success with large established mutual fund players who wanted to launch their first ETFs and they found the series trust structure to be beneficial, eliminating the need to make the required changes to their existing mutual fund trusts and time to educate existing board members on the ETF structure. These clients decided to go into an established series trust structure with trustees that have ETF experience and chose a service provider that could offer them a turnkey solution that got them into the ETF marketplace quickly and efficiently.
We continue to have conversations with investment managers who are interested in non-transparent/semi-transparent ETFs. These structures do not require disclosure of daily portfolio holdings and have similar holdings disclosures as mutual funds. The ability to shield daily disclosure of alpha generating securities resonates with many active managers. Although non-transparent and semi-transparent structures have gained a lot of interest, I would say, for the most part, we are seeing more transparent active ETFs coming to market than semi-transparent and non-transparent options as many are waiting to see how these structures will work in the marketplace. We have enhanced our operating model and developed the necessary operational workflows to support the various ETF structures and are ready to share our experiences and work with our clients to launch whichever strategy they choose.
Within our service model, Ultimus provides fund accounting, basket services, financial reporting, legal administration, tax, compliance, fund officers, and distribution services. Our flexible service model allows clients optionality in choosing an auditor, custodian, and legal counsel. Our clients leverage our deep industry knowledge and strategic partnerships to make industry introductions to market makers, authorized participants, and listing exchanges. Our ability to connect into the ETF ecosystem with key players provides efficiency, straight-through processing, and aggregation and distribution of fund data to market participants.
Hortz: How can a fund administrator support and help implement innovation in ETFs?
Prendergast: As clients expand their product offerings and may be looking to get into other asset types, like bank loans, emerging markets, or increased use of derivatives, we guide our investment management clients in sharing industry best practices to make sure they understand what is going to make an ETF successful and how they can put new asset classes into an ETF structure that the market will understand and accept.
We have developed operational workflows that support new and innovative ETFs. Leveraging our proprietary ETF processing technology, uETF, we have the infrastructure needed to support the timely creation and dissemination of basket and portfolio holdings data that the market requires to trade ETFs in an efficient manner. We also have a team with deep institutional knowledge and decades of ETF experience that have helped various firms come to market with new ETF offerings. Since January 2021, Ultimus has assisted over 16 advisors launch new products. We want our clients to leverage our ETF experts and utilize them as an extension of their product management team in developing new products that will be operationally efficient in the ETF ecosystem and well received in the marketplace.
Hortz: Where do you see the ETF market going from here?
Prendergast: We see and expect continued growth in ETFs, especially with record industry inflows this past year. In 2023, we expect that growth momentum to continue. Actively managed ETFs continue to pique the interest of the industry and make up the majority of new ETFs. We continue to see interest from new market entrants and asset conversions from other structures such as mutual funds and SMA accounts.
We also expect growth to continue with new product offerings ranging from equity, actively managed, fixed income, ESG, and more complex products looking for exposure to emerging markets, derivatives, and single stock ETFs. With significant investments in technology and people, we have created a scalable operating model and in-depth consulting capability that is well-positioned to service our clients’ business needs and anticipated industry growth.
Hortz: Any advice or recommendations you can offer asset managers with ETFs or thinking about launching an ETF?
Prendergast: If starting out, begin with an investment strategy that has a strong track record and where you have a proven area of expertise. Know your target audience and have a plan of how you will gain/attract assets. Understand how you will market and sell your product through new distribution channels in advance.
Consider potential new hires that have ETF operations, sales, and distribution experience. Pick your service providers early in the process. They are an important part of any successful launch. Leverage their deep industry expertise, their ability to provide you with key industry introductions, share in industry best practices, and they can help keep you on track for a timely and efficient ETF launch.