Investors can now choose from nearly 2,000 products from more than 80 issuers, and the industry currently holds more than $3 trillion in assets.
What began as a quirk to the mutual fund in the early 1990s has transformed into a standard form of investing for retirement savers and financial professionals.
As the industry continues to grow, so, too does the competition for attracting investors' attention to new products.
A little more than a year ago, the PureFunds ISE Cyber Security ETF (HACK), an ETF that tracks a group of companies that provide services to protect an organization's sensitive data or private networks, launched. In its first nine months, it accumulated more than $1 billion in assets.
This is not how every ETF launch works. Some will take off, some will methodically grow over time, and others will eventually close. Still, HACK reveals how a team effort and a compelling idea can make its presence known in an industry where a handful of dominant firms and smaller players compete aggressively for assets.
HITTING THE BOOKS
Turning an idea into an investable index, and eventual ETF, doesn't happen overnight. Sometimes, it could take many months, if not years, before that concept proves - or disproves - its value.
This incubation phase is busy. The time is spent on careful research to evaluate the viability of the investment theme within these primary characteristics:
• Idea generation (Is the investment theme intuitive? Can investors easily define it?)
• Existing challenges (Does this solve a problem that exists in the investment management industry?)
• Exposure (Is the product an access play? Does it provide exposure that is otherwise unavailable in the marketplace?)
• End goal (What is the proposed ETF meant to achieve?)
For cyber security, the concept also had mainstream appeal - it was (and still is) dominating the 24-hour news cycle. Cyber attacks are becoming more frequent and touching more individuals as identity theft increases.
The lingering threat of data breaches has forced businesses, government agencies, and families to rethink how they manage sensitive information.
To master the cyber security competitive landscape, we conducted research like analysts - we called dozens of investor relations teams - to understand how companies generated revenue from cyber security and to identify and categorize their offerings.
Companies and index providers characterize their activities differently. For example, while some firms do not specifically label themselves as cyber security companies, our analysis concluded they were actually providing a line of defense in front of hackers.
The findings of our research showed the strong potential for cyber security as an investable technology sector.
PLANNING AND PATIENCE
After the research, the work was just beginning. Every aspect of an ETF has to be considered, and timing the launch properly is critical.
Considerations big and small are significant, ranging from highly visible decisions, like selecting the ticker symbol and establishing the brand name, to the decisions necessary to "keep the lights on," like choosing the proper directors and officers liability insurance and writing the prospectus.
Further, important steps include development of distribution and marketing strategies, choosing prospective partners for issuance who have exemptive relief, and ensuring the product adheres to listing rules and other regulations.
All of that research comes in handy when choosing when to launch the ETF. If it launches too early, the ETF may never pick up enough assets and could eventually close. If you wait too long, a competitor may beat you to the market.
HACK launched just a few weeks before the holiday shopping season, sandwiched between announced data breaches at Home Depot and J.P. Morgan, and Staples and Sony. It was these hacks that reinforced the industry's significance.
LESSONS LEARNED
Many ETFs do not make it to $1 billion in AUM. Yet, looking at our experience with HACK, there are four takeaways that could help improve an ETF's chances for success.
• With so many ETFs available to investors, it is important to honestly consider whether a new product will fill a void, add diversification to a portfolio, and/or benefit the industry.
• If the idea is too complex, it will be more difficult for the ETF to resonate with the investing public.
• Choosing partners with the right experience is another contributing factor, as it allows everyone to pool resources and divide and conquer challenges based on everyone's specialty.
• None of this can begin, though, without expert-level knowledge of the sector, the companies that populate it, and the patience to understand the right time for launch.
HACK has proven that there is an appetite for diversified investing in cyber security, but it also proved something else.
It proved that, even in a crowd of thousands, it is still possible to stand out.
Kris Monaco is the head of ISE ETF Ventures, where he oversees all ETF financing activity and partnerships, derivative product development, index development and index licensing.
