New ETF Providers Face Challenges and Rewards

by: Tom Lydon

The ETF industry has nearly 1,000 funds in the United States alone and nearly $800 billion in assets under management. Amid all this growth has come intensifying competition for new entrants into the space.

The pressure for new providers comes on several fronts: they need to have the time and devotion to wind their way through the various regulatory hurdles, they need to have the startup money and, perhaps most importantly, they need to have a unique angle that ensures their product stands out from an ever-growing crowd.

The Launching Process

Grail Advisors is one such relatively new ETF provider that successfully jumped over the various hurdles. Grail launched the industry’s first actively managed ETF in June 2009 – Grail American Beacon Large Value (NYSEArca: GVT).

The launch of a new ETF, especially when it’s your first, is a significant time and financial commitment. That means that if you want to be a player in the ETF industry, you’ve really got to want in.

Stacy Fuller, a member of the investment management practice group at K&L Gates, says, “I think they need to be prepared to make a real commitment and investment in the ETF marketplace. ETFs don’t always sell themselves; there can be big startup costs for an advisor.”

Every ETF starts with a filing with the Securities and Exchange Commission (SEC) for exemptive relief. This process alone can take anywhere from 9-18 months, says Fuller, who counsels actively managed, index-based and leveraged ETF providers on the exemptive application process.

The filing process for Grail took about 14 months, which was slightly longer than hoped, given that the provider was securing relief for a first-of-its-kind fund. [Pure-Play ETFs: Worth the Risk?]

After the exemptive relief is obtained, the ETF needs to be registered, which takes another 60-90 days, depending on the ETF’s strategy.

Once registration is done, the ETF provider needs to work with the SEC’s Division of Trading and Markets, get an interpretive letter and a listing standard.

“These are things any ETF needs, but the process is longer for actively managed ETFs,” Fuller says. This is largely because the groundwork has been laid for index-based ETFs to skip many of these steps, but that groundwork isn’t yet in place for actively managed ETFs.

“It can take quite awhile to get a new ETF out the door if you’re starting from scratch,” she says.

New ETF providers should be sure they’re going into ETFs for the right reasons. Given the time and money involved in getting funds off the ground, the passion has to be there.

William Thomas, Grail Advisors CEO, says that new entrants are often either moving into the industry for offensive or defensive purposes. In other words, they’re either doing it because ETFs are the hot, new thing or because they truly have a vision for their product.

“A lot of firms are doing it for defensive purposes, and not really quite sure of what they want to do in the ETF marketplace,” says Thomas.

Finding the Right Partners

From the get-go, Grail’s vision was to secure subadvisors for all their funds and not manage money themselves. Thomas says they also don’t want to be tied to one investment firm for all of their strategies, but to find the best match for each strategy through a careful due diligence process.

“It was one of the core tenets we had at Grail. It made sense to partner with people whose expertise was money management.”

Grail’s partners Brandywine Global Investment Management, Hotchkis & Wiley Capital Management, Metropolitan West Capital Management, RiverPark Capital, Western Asset Management, Wedgewood Partners and McDonnell Investment Management.

Another aspect of getting a suite of ETFs off the ground is finding the right people to partner with, which includes market makers, exchanges and authorized participants. Linking up with such people has gotten easier these days. The New York Stock Exchange and Bank of New York, for example, have departments that will link up those wishing to launch ETFs with index providers, market makers and other key people who can get the process rolling.

Getting Easier

While the launch of Grail’s first ETF was a learning experience, Thomas says they get a little smarter with each subsequent launch.

“You get smarter with every fund launch and the way you bring products to market and the way you market it.”

He also feels validated in Grail’s decision to launch actively managed funds. Since Grail’s initial fund launch, a slew of other providers have launched their own actively managed funds or announced their intentions to do so, including PIMCO, AdvisorShares, T. Rowe Price, Eaton Vance and JP Morgan.

”That’s very confirming that we led the industry in this new marketplace,” says Thomas.

Fuller at K&L Gates says that one of the biggest challenges new ETF providers face is that ETFs are not completely well understood by much of the investing public and that there’s more education left to be done.

“While there has been a lot of education to date, I would say there are still challenges to selling an ETF.”

Industry Growth

Despite the more intense competition in the ETF industry these days, Thomas still feels like there’s a lot of room for growth.

“I think you’re going to continue to see entrepreneurs like ourselves bring new creative ideas, and you’ll see older firms come into the space, as well.”

For those new players, Thomas has some simple words of wisdom.

“They should just be prepared for a tremendous amount of hard, but fun, work. I think it’s wonderful to be on the forefront of something so wonderful as ETFs.”

In addition to GVT, Grail has six other ETFs:

  • Grail McDonnell Intermediate Municipal Bond (NYSEArca: GMMB)
  • Grail McDonnell Core Taxable Bond (NYSEArca: GMTB)
  • RP Growth (NYSEArca: RPX)
  • RP Focused Large-Cap Growth (NYSEArca: RWG)
  • RP Technology (NYSEArca: RPQ)
  • RP Financial (NYSEArca: RFF)