Since their market debut more than two decades ago, ETFs have shown impressive growth and continued promise as prospective investment options. Delivering key benefits to investors including market-driven intraday pricing and liquidity, lower costs, and tax efficiencies, both passively and actively managed ETFs continue to launch at a rapid pace today.

Pre-Launch Capital Considerations

Identifying pre-launch sources of AUM for your ETF is a vital consideration. There are two categories to consider; captive AUM refers to current client assets, such as existing SMA or mutual fund assets that you can legally, compliantly, and efficiently allocate to the ETF as part of, or shortly after, launch. A second source, captured AUM, refers to assets gathered through traditional wholesaling and marketing activities. If a captive AUM source is not accessible, a carefully crafted and executed plan to capture AUM is essential.

A key component to a successful wholesaling and marketing plan to capture AUM includes identifying wire houses, regional platforms, and other RIAs who currently use your existing products and indicate strong interest in owning your ETF. They can provide a target AUM level to help estimate first year revenues and expenses.

Passively Managed Versus Actively Managed ETFs

Passively managed ETFs allow investors access to passive strategies that track an index, while active strategies allow a manager to select securities. Similar to index mutual funds, passive ETFs track a specific index as detailed in its prospectus. Passive ETFs generally need to rebalance, or match, their portfolio holdings to the specific holdings of that index at specified dates, referred to as the rebalance schedule, in their prospectus. This is typically done on a quarterly, semiannual or annual basis. Actively managed ETFs do not track an index, and therefore are not held to index holdings or a rebalance schedule. This provides the actively-managed ETF portfolio manager the same flexibility as an actively-managed mutual fund manager, and allows them to trade their portfolio at any time during the trading day.

An ETF Sponsor's strategy primarily drives the decision to utilize a passive or actively-managed methodology. Specifically, if an index is available, or to be created, to drive the investment thesis, naturally passive management is utilized. If a sponsor's strategy does not fit with a static rebalance schedule as determined by an index, active management can be utilized. For example, many times a value-oriented strategy may require a manager to act on a daily basis accumulating undervalued stocks and capitalizing in stocks that have reached a targeted profit or loss level. Furthermore, many ETF strategies today utilize indicators, which trigger a move to cash or a reduction in securities exposure. Passive ETFs may rely on an index with a quantitative, objective rule for doing so, whereas an actively-managed ETF can move to cash whenever the manager decides to do so.

Filing for Exemptive Relief

Prior to ETF launch, managers must determine whether they want to file for their own actively-managed and/or passive ETF relief or rent relief by hiring an investment adviser that already has exemptive relief. As a registered product, an ETF’s investment adviser must obtain exemptive relief from the SEC for the ETF to remain compliant with the Investment Company Act of 1940 before it can be offered to the public. This approval process allows the ETF to be exempt from key mutual fund limitations and enables key features of an ETF, such as the purchase and redemption of creation units, purchase and redemption timelines, and in-kind trading requirements.

Continued demand for ETFs has fostered innovation and efficiency with issuers, service providers, and the SEC. Streamlined application processes and increased familiarity with product structures, securities utilized within portfolios, and management techniques have shortened the application, approval, and launch process. This includes the 19b-4 application process exchanges must go through prior to listing certain products.

While improvements have been made, because exemptive relief is required prior to release, enlisting a partner familiar with the process can be essential to the efficient launch of a new ETF. Depending on the complexities of the specific strategy being employed in the ETF, the process and required resources may greatly vary.

Overcoming Exemptive Relief Issues with ETF Multiple Series Trusts

Advisers who want to streamline their time to market may choose a "shared" or "turn key" trust also known as an ETF Multiple Series Trust (MST). This structure allows access to the resources advisers need for launch support for their funds. This unique structure allows participants in an MST to select from multiple methods of securing required passive and/or active exceptive relief. Advisers may use their own exemptive relief, request that a service provider file for it on their behalf, or leverage a third party’s existing exemptive relief provided through their preferred service partner. By using a turn-key MST solution and leveraging a team of experts, advisers can focus on managing continued growth while avoiding the operational and regulatory complexities of starting an exchange-traded fund.

Knowledgeable Partnerships Create Success

Selecting an experienced service provider who can provide consultative launch support in addition to ongoing administration, accounting, transfer agent, custody and distribution services is also essential to successfully bringing a new ETF to market. The greatest operational and cost efficiencies can often be achieved by using a provider who offers full service options and key advisory resources including trustees, compliance staff, tax, legal, and index receipt agent support. This service offering should be built on both state-of-the-art technology for create/redeem order entry and seamlessly integrated internal systems to provide necessary access and reporting capabilities for the client and capital markets participants.

Senior Vice President Mike Castino serves as business development officer for the Exchange Traded Funds division of U.S. Bancorp.

Subscribe Now

Access to premium content including in-depth coverage of mutual funds, hedge funds, 401(K)s, 529 plans, and more.

3-Week Free Trial

Insight and analysis into the management, marketing, operations and technology of the asset management industry.