The biggest challenge for any new firm considering an entry into the ETF market is overcoming the regulatory hurdles placed between a product and customers. Few understand that difficulty as keenly as Eric R. Ervin, CEO and co-founder of San Diego, Calif.,-based ETF provider Reality Shares.
In the second part of a conversation with Money Management Executive, Ervin says after the launch of his firm, it took roughly three years to receive regulator approval for their product. In that time the former Morgan Stanley advisor was faced with some crucial decisions to make, from hiring decisions to budget allocations.
"Sometimes we'd get to a point where we would be told, 'Well, we have no further questions,' and we'd have our hallelujah moment," Ervin said. "And then they'd come back with, 'At this time.' "
Given your mentoring background at Morgan, what did you do to motivate your team and provide them with a sense of confidence?
As a brand new financial advisor -drawing on that previous experience at Morgan - you don't know anybody and you have to convince somebody to give you their money over the phone, and they've never met you. That is the most painful, dreaded thing in any new financial advisor's day. And that is what I had to do, day after day, and get kicked in the teeth, day after day. So I broke it down into these tiny baby steps. I'd say, "I'm going to make 15 calls, and then I can get up and take a break. And I'm even going to give myself a little reward - a quarter in the jar, and the second I get four quarters, I'm going to go buy a coffee." I'd play these little games with myself, just to do the awful thing that was cold calling. Eventually that mini-reward system isn't necessary, because you develop that thicker skin, you learn to talk to people and things start going better. It just starts to snowball up rather than melt away.
So that's the big thing with our employees: How can we build in these little behavioral reward systems in the things that are tough. Whether that's calling into S&P even though they don't know how to do it, or getting quotes from some of the major investment banks, and they feel like they don't want to bother them. You tell them, "You know what you did it today, great job. It wasn't that hard."
You're constantly reaffirming, and continuing that cycle of small rewards, maybe making a target and providing compensation if they meet those targets. It's mostly about rewards, not so much about punishments.
Everyone in a leadership role has their own moments of doubt. You ask yourself, "Did we make the right decision, do we really understand the product we're trying to sell?"
So many times we were faced with these situations - there was a lot of hurry up and wait, especially in the regulatory process. You don't know when you are going to get approved. Yet you've got to make these hiring decisions based on whether or not you're going to get approved. You have no knowledge and no wisdom there. We just decided to hire and assume we were going to get approved. Let's take the positive, optimistic approach, but let's keep in mind that these guys are going to get frustrated as we get delayed, because there's nothing for them to sell. And because there's nothing for them to sell, there's no income - there's a salary, but not what they are used to. So how do you motivate them, to tell them to hang in there and reinforce that we're going to be awesome and huge?
It's really just being like a family, where everyone is dedicated to the mission of what we're doing. Not just for the promise that we're going to make a lot of money. Most of us came from the world of investment management. It's that we will finally be able to do this. Clients will be able to invest in just the dividends. Financial advisors are going to be able to tell their clients, hang in there, because you don't have to worry about whether the market is going up or down. Just, do you think Coke is going to raise their dividend or shrink it? We're giving this thing that people want and that's what keeps us motivated.
Your hiring decisions must have been very important.
They were incredibly challenging. In hindsight obviously we made a - well, I don't know if it was a mistake, honestly. Because it gave the sales team the opportunity to go out and talk to the market while there was no product, just to test the market and change, test the brand and go through some of these ideas. We'll see whether it turned out to be a bad decision, but if you were standing on the outside you could definitely critique me on that one, which was hiring too early and not adjusting for that.
I'm pretty good at planning, so we doubled everything. Everything we thought we were going to spend, we doubled it in terms of our budget. We have plenty of capital as a result, because we expected it to take twice as long and cost twice as much. That's fine, but it just stinks to have to use the contingency.
You're in a unique position to talk about how regulation puts barriers to entry for new companies into the market. As a small firm, how did you get through a process that is difficult even for large firms to manage?
It's been three years since we started the firm, and we're just now getting our first product approved. So think about the amount of capital that was spent, the amount of brain damage suffered: "Why won't this end?" And also, the education required. In our case, in hindsight, as challenging as it has been, it was a good experience.
The SEC was very professional and we were really impressed how they did their homework and cared about the individual investor. It wasn't dealing with a staffer who worked 9 to 5. There were moments, where you would be stewing, "Why isn't this getting off that person's desk? Oh she's on vacation. What do you mean, she's on vacation?" So that was frustrating. But the questions that they asked of us and the reasons they asked those questions, you could tell they were all based on the premise of, "Is my mom going to lose money if she invests with you?" I liked that, and I have a lot of respect for that part of the process. It's just the length of it.
Sometimes we'd get to a point where we would be told, "Well, we have no further questions." And we'd have our hallelujah moment. And then they'd come back with, "At this time." We'd then ask when would they have questions, and the response was, "Maybe we won't." So there was no clarity. And right before deadline, they'd say, "Hey, we have a few questions." We'd wonder why they waited until that moment, but it was because they were handling other issuers, and they only had so much bandwidth. Without that aspect, you might be able to launch in half the time.
You brought up mom, so I'd like to know what you told your family about making the switch from being an established financial advisor with Morgan Stanley to a startup in ETF products.
It's simple when you talk about it as a solution. I had individual clients and I cared a lot about them. They relied on me to do the right thing for them. It was so frustrating to tell them they were losing 30% of their wealth; it wasn't going to change their vacation schedule, but still, it was a lot of capital that would just evaporate, and then come back. My clients hated the market. "It's up one day, it's down the next, I'd rather put my money back into my own business." That was the mentality many of my clients had. I knew if I could bring them this solution, even if I was a financial advisor, they would appreciate it. So the fact that nobody did it, I made up my mind that I would. From that perspective, people understood. As a financial advisor, you're in the trenches, you see the problem.
How comfortable are you being in ETFs now, rather than financial advice?
It's great. As a financial advisor, you're a blend of counselor, helping people and learning how to talk to people and communicate your points effectively. It's in a way like a physician. He still has to convince you to exercise more, to eat better. He can write you prescriptions and help you with little problems, but his biggest problem is, "How do I make you a healthier person?" And that's what the financial advisor does, he wonders how he can persuade his clients to like him enough to continue to work with him, but also how to build a comprehensive financial solution and keep them in that. Now take that skill into the role of a CEO of an ETF company. You still need to persuade your employees to work harder, you still need to persuade prospects to buy your new product, you need to persuade service providers to give you better pricing. Of course, you also need the practical skills to build the product.
And, I have that optimal perspective - I know how many crappy products came through the door that did somehow make it onto a platform. I know they get a rap sometimes, but I have this belief that advisors are very intelligent. They are managing their clients' money and they are the closest to the client in that decision process. They know best what the client needs and doesn't need. It's not a firm's due diligence department. That might be some 27-year-old analyst who really doesn't know how to take care of client assets, but he made up some rules as to what will and what won't make it onto a platform. That was always frustrating as an advisor, our client would want to do something but couldn't, because it hadn't been through "the process." So there were those ambiguities of the bureaucracy at the firm level, and then the wholesaler process as well. In any market there are probably four good wholesalers. There's so much money being spent on wholesalers just going through the motions, they don't understand the investment business, they are just trying to sell a product.
ETFs have now caught on with investors at large. You must feel good about the timing of this venture.
That was the genesis of this. (Co-founder) Mike Rosen said we have to get into the ETF business, there's such a tremendous opportunity right now. So many fund management companies know they're losing money, the writing is on the wall. I knew I could create something compelling and do it in an ETF. The industry has evolved enough now where this solution can be delivered in an ETF, and they had an idea to get into the ETF business.
I do think that innovation and change is going to keep coming, and the ETF is a good tool for investors. But it's just that, it's a delivery mechanism. I was one of the first users of ETFs in the early 90s among my sphere of advisors. With regards to creation, redemption and much of the mechanical aspects of ETFs, I've learned a lot. Those systems developed with the SPDR, and now it's about how do you use those systems.