While industry growth reveals the continued adoption of ETFs and their impact on distribution strategies, a closer look also uncovers operational pain points and the need for asset managers to re-evaluate their ETF and mutual fund product lines.
Brian Reilly, vice president of ETF sales and relationship management at Brown Brothers Harriman, speaks with Money Management Executive about the active ETF industry and why the stakes are now higher than ever for mutual funds.
Q: What are the implications of ETF growth impacting the mutual fund industry?
The stakes are high for the mutual fund industry in that ETF adoption continues to increase across almost every channel, and will soon break into the much coveted 401(k) space. This comes as Schwab announced the launch of their ETF-only 401(k) earlier this year. Asset managers are aware of the ETF growth wave and they are working to craft strategies to: a) build and launch products, b) acquire a smaller provider, c) identify opportunities to package ETFs into existing and new products, d) observe and assess future entry, or e) compete with ETFs rather than sponsor ETFs.
Many mutual fund providers choosing not to enter the ETF marketplace are refining their investment strategies and focusing on consistently providing alpha. In some cases, providers are also evaluating ways to reduce the costs of managing funds to ensure they are competitively priced in the marketplace.
Asset managers that offer both mutual funds and ETFs are most frequently challenged by the impact to their distribution strategy of creating a dedicated ETF wholesaling force, how to track ETF sales given the exchange-traded nature of the product structure, and the impact to revenue sharing arrangements with distribution partners/platforms.
From a product and marketing perspective, managers are focused on how to brand their ETF product line and determining if the product set is designed to mimic or compliment their existing mutual fund products.
Q: How are the biggest operational pain points among ETF service providers and how should they overcome them?
Overall, the infrastructure to support passive ETFs is flexible enough to service the new fund types so we do not anticipate a need for significant infrastructure builds to support the new proposals, rather system updates to address new client and regulatory-requirements.
We have been preparing for these changes in order to work new levels of flexibility and customization into our systems. The key for ETF managers will be to work with service providers who are skilled in developing the processes and infrastructure to support the new requirements.
Q: Active ETFs still represent a small percentage of the ETF industry. Do you see that changing?
'Active' strategies comprise just 1% of ETF assets. The growth of active ETFs will likely take a bit more time, and developments in the regulatory environment will certainly impact the rate of growth.
Overall, the greatest opportunity hinges on whether the SEC will approve non-transparent active ETF strategies, which would allow managers to disclose holdings with the same frequency as mutual funds rather than complying with the daily disclosure of holdings required for ETFs today. If the change in disclosure requirements is approved, it could certainly lead to faster, more explosive growth in the near-term.
Q: How can fund providers benefit from active ETFs / should they?
With the advent of new investment vehicles, pockets of capital are leaving traditional actively managed funds in favor of other investment strategies, including actively managed ETFs.
This presents a real opportunity for asset managers that can effectively structure active ETFs and are willing to dedicate the requisite funds and distribution support to market this evolving capability.
In order to be successful, firms may need to evolve their culture to accept a 'structure agnostic' approach that will allow them to optimally "package" their intellectual capital in a new way.
Q: How are providers coming to market with active ETFs? What business models are out there today?
Any approval by the SEC to allow non-transparent active ETFs could open new product opportunities for managers and thus, substantially change their go-to-market strategy.
For example, both Precidian Investments and Eaton Vance's Navigate Solutions are lead purveyors of distinct patented approaches that haven't been marketed to date. Navigate's proposal is focused on a new fund structure called the Exchange Traded Managed Fund (ETMF) which trades on an exchange throughout the day, but requires investors to buy and sell shares relative to the fund's NAV at the end of the trading day.
Q: What are the areas of growth in the industry?
On August 1, Broadridge Financial Solutions released new data showing that the RIA channel increased their long-term mutual fund and ETF assets under management by more than 12% in the first half of 2014, marking the first time the RIA channel had grown at a faster rate than all other retail channels.
For some time now, ETFs have been a major beneficiary of increased RIA adoption of ETF specific models, SMAs, and other products that "package" ETFs. Similarly, in the broker-dealer channel, the increased use of fee-based managed accounts has contributed to the wave of ETF growth.