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At The Money: Building an ETF · Masters in Business

• 0:02
  Speaker 1: Bloomberg Audio Studios, podcasts, radio news.
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  Speaker 2: Yes, mutual funds, trusts and ETFs. Have you ever wondered
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  Speaker 2: how these are put together? Are you an analyst, strategist
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  Speaker 2: or fund manager that has a really good idea? Have
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  Speaker 2: you thought about launching a fund to employ that idea?
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  Speaker 2: I'm Barry Ridolts, and on today's edition of At the Money,
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  Speaker 2: we're going to discuss how to build your own exchange
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  Speaker 2: traded fund or ETF. To how help us unpack all
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  Speaker 2: of this and what it means for your portfolio. Let's
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  Speaker 2: bring in Wes Gray of ETF Architect. He helps managers
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  Speaker 2: turn strategies into ETFs by providing turnkey, white labeled platforms
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  Speaker 2: that handle legal, compliance, operations, portfolio management, allowing sponsors to
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  Speaker 2: focus on the idea and distribution. And Wes also runs
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  Speaker 2: the Alpha Architect shop as well. Full disclosure, Wes Gray
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  Speaker 2: and ETF Architect are helping my firm, Retults Wealth Management
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  Speaker 2: launch a new ETF later this year. So Wes, let's
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  Speaker 2: start with the basics. If I'm someone with a novel
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  Speaker 2: strategy and a good idea for a ticker, what are
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  Speaker 2: the elements that determine whether or not this ETF launches
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  Speaker 2: or whether it just dies on the vine.
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  Speaker 3: Well, I think it's going to come down to low fees,
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  Speaker 3: capital and passion. In ETF market, as you know, you
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  Speaker 3: got to have low fees for the most part, or
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  Speaker 3: peep an't going to buy your product, and low fees
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  Speaker 3: means you also got to have a lot of capital
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  Speaker 3: to back this thing, because you've got to be around
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  Speaker 3: for at least three to five years and tell your story,
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  Speaker 3: and then you've got to have the passion.
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  Speaker 4: You're in a.
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  Speaker 3: Market competing with monopolies like Blackcroc and Vanguard, So you
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  Speaker 3: got to be someone like a per tole that we
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  Speaker 3: talked about previously, where you just have to go knock
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  Speaker 3: on doors and tell people why your product in your
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  Speaker 3: story is so great.
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  Speaker 2: Huh really interesting. So I'm curious as to the timeline
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  Speaker 2: from the original conception to trading day. What's the realistic
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  Speaker 2: timeline and where are the common bottlenecks.
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  Speaker 4: So we generally tell folks four months you sign the
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  Speaker 4: letter of.
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  Speaker 3: Intent and you're ready to whoop it on, we can
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  Speaker 3: get this thing out at the door and plus or
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  Speaker 3: minus four months. Obviously that could go out to four years.
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  Speaker 3: It depended on your own internal issues. But we've got
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  Speaker 3: this thing so checklist and automated. At this point, if
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  Speaker 3: you want to launch in four months for like a
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  Speaker 3: relatively straight forward ETF, that's going to be possible.
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  Speaker 2: Four months seems really short, but I guess I'm imagining
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  Speaker 2: how long it takes to accumulate enough seed capital launch.
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  Speaker 2: How much money under management do you need to launch
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  Speaker 2: an ETF? How does that get structured? What's the usual
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  Speaker 2: launch dollar amount?
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  Speaker 4: Sure, so this is a moving target.
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  Speaker 3: And let's say four or five years ago, we would
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  Speaker 3: have said, hey, five million minimum. Now we tell people
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  Speaker 3: twenty five million, and I'm about to probably move it
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  Speaker 3: up to fifty million. And really it's not because of
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  Speaker 3: the operating costs of the ETF's to convey.
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  Speaker 4: Credibility to the marketplace.
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  Speaker 3: We need like people just everyone kind of knows, like, hey,
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  Speaker 3: where's your break even? You know, because I want you
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  Speaker 3: to be in business three to five years from now,
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  Speaker 3: and usually that break even in people's minds is twenty
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  Speaker 3: five to fifty milis so anyways, high barrier to entry
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  Speaker 3: just on that. Ye, Now, how do you see these things? Well,
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  Speaker 3: there's basically two methods. Either seed with cash, so you
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  Speaker 3: launch the ETF and people go open up their Schwab
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  Speaker 3: account and click the button and you know, pay cash
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  Speaker 3: to buyer ETF, or you can seed it with property,
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  Speaker 3: where there it's a little bit convoluted, but there's a
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  Speaker 3: thing called section three fifty one where you can actually
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  Speaker 3: contribute property tax free to seed the ETF. So basically
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  Speaker 3: cash or property is the two methods you can use.
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  Speaker 2: And I'm assuming property is usually individual stocks or bonds.
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  Speaker 2: Is that right?
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  Speaker 4: Yep, you got it.
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  Speaker 3: So if you have a portfolio of securities public securities
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  Speaker 3: that naturally fit in the CTF, you can contribute those
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  Speaker 3: tax free and then that that property serves as an
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  Speaker 3: initial seed for essentially the launch of the ETF.
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  Speaker 2: So you mentioned break even take me into the minutia
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  Speaker 2: of what the back end of this looks like, legal, audit, administration, listing,
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  Speaker 2: distribution marketing. What are the big costs that any ETF
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  Speaker 2: manager has to run? Where do people kind of make
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  Speaker 2: mistakes with these?
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  Speaker 3: So yeah, I'll kind of reverse the question and let
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  Speaker 3: me tell you what we've done, the cost and what
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  Speaker 3: you have to do, because what you're asking about is
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  Speaker 3: a total dumpster fire behind the scenes. But essentially for
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  Speaker 3: Our platform is like you show up with the spreadsheet,
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  Speaker 3: tell us what to do, and you go market and
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  Speaker 3: distribute this thing comma compliantly. Because we have oversight responsibilities.
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  Speaker 3: That's your two primary jobs. Now we're going to deal
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  Speaker 3: with all the dumpster fire behind the scenes and the
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  Speaker 3: generic cost of doing this to launch an ETF again
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  Speaker 3: all sandbag for a generic ETF. Just with easy numbers,
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  Speaker 3: you're looking at a fifty k startup, soup the nuts
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  Speaker 3: and then, which is not the bad news. The bad
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  Speaker 3: news is the ongoing cost to deal with all the
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  Speaker 3: aspects you'd just talked about. And you know it's plus
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  Speaker 3: or minus, but you're looking around two hundred k year.
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  Speaker 3: So what the heck does that mean as a business setup. Well,
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  Speaker 3: you know, if you share one percent, your break even
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  Speaker 3: is twenty million. If you charge twenty basis points, which
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  Speaker 3: is much more marketable, your break even is one hundred million,
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  Speaker 3: and then everything in between. So obviously your break even
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  Speaker 3: depends on your fee. But you're looking at two inner
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  Speaker 3: k burn a year on average.
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  Speaker 2: Let's say someone comes to you with a systematic strategy.
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  Speaker 2: How do they decide whether or not this is based
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  Speaker 2: on an index and running it fairly statically versus a
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  Speaker 2: more active ETF that's run more dynamically.
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  Speaker 4: So in this advice has also changed over time.
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  Speaker 3: We're in the old days we would say, hey, index active,
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  Speaker 3: there's a bigger trade off there. Now it's almost always
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  Speaker 3: the case just go active, even if your strategy is
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  Speaker 3: one hundred percent systematic. Why is that, Well, there's this
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  Speaker 3: low overhead cost. I don't have to pay for a
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  Speaker 3: third party index agent. I'm going to pay for third
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  Speaker 3: party service providers, and I also have a little bit
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  Speaker 3: more flexibility at the margin. So for example, let's say
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  Speaker 3: I'm on an index versus an active and I'm doing
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  Speaker 3: the exact same strategy, but we know this week there's
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  Speaker 3: going to be three FED meetings and you know the
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  Speaker 3: world's going to blow up. I might not want to
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  Speaker 3: rebalance this week. I'll just punt to next week. That's
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  Speaker 3: easy in an active strategy. In an index strategy, that's possible.
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  Speaker 3: But the paperwork trail and the compliance to be able
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  Speaker 3: to facilitate that's essentially a nightmare, which means most index
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  Speaker 3: funds just follow the book no matter what on like
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  Speaker 3: little minutia decisions like this. So we recommend active at
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  Speaker 3: the margin.
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  Speaker 2: So you must see a ton of different strategies. What
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  Speaker 2: do you see that really shouldn't be put into an ETF?
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  Speaker 2: What kind of strategy even if a manager is passionate
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  Speaker 2: and excited about the idea, what are the sort of
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  Speaker 2: red flags that, hey, you don't want this in an ETF.
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  Speaker 3: I mean, I'm I don't know if I'm weird or
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  Speaker 3: just old school or conservative, but if I'm not going
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  Speaker 3: to recommend this to my parents or my grandma, why
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  Speaker 3: do we have this in an ETF where anyone with
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  Speaker 3: the Schwab account can click the button and have a party.
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  Speaker 4: Right? So what does that mean?
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  Speaker 3: Things like double lever, triple levered Whatever's a lot of
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  Speaker 3: these gimmicky products that are extremely expensive and they have
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  Speaker 3: tons of embedded costs be like swaps and a lot
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  Speaker 3: of other things that aren't transparent.
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  Speaker 4: I can't stand those products personally. Does that mean that
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  Speaker 4: people won't do them? Well, of course not.
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  Speaker 3: If you can sell out the people that are gonna
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  Speaker 3: pay one percent for your stupid idea, great, But I'm
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  Speaker 3: not a big fan of having those products in the
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  Speaker 3: ETF marketplace.
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  Speaker 2: So you're not a big fan of the inverse three
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  Speaker 2: x levered bitcoin ETF.
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  Speaker 4: I No, I'm not a fan.
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  Speaker 3: Again, maybe I'm just a funny duddy and I need
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  Speaker 3: to move on in the world.
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  Speaker 4: But I just kind of old school. I like, you know,
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  Speaker 4: low fees, transparent, tax.
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  Speaker 3: Efficient things that people can understand that presumably add value
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  Speaker 3: in the long game.
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  Speaker 2: So let's talk about some of the block and tackling.
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  Speaker 2: Once an ETF is created and launched, how do you
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  Speaker 2: think about what I think about as someone who is
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  Speaker 2: on a trading desk as good market behavior meaning tight spreads,
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  Speaker 2: reasonable liquidity, especially if the ETF is holding some assets
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  Speaker 2: that are perhaps a little less liquid than than average.
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  Speaker 3: Yeah, that's a great question, and it creates a lot
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  Speaker 3: of confusion in the marketplace. And so what there are
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  Speaker 3: there's basically two types of ETFs. One will call liquidity diamonds.
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  Speaker 3: These are ETFs that everyone knows right like spy triple
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  Speaker 3: Q or. When you go and transact in those ETFs,
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  Speaker 3: it's very likely that you're actually trading shares with someone
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  Speaker 3: else who actually owns those ETF shares. That's rare, right,
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  Speaker 3: because it's just such a huge market. The other set
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  Speaker 3: of ETFs, which is ninety nine point nine to nine
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  Speaker 3: percent of them is normal ETFs where when you go
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  Speaker 3: access to marketplace, you're accessing what they call primary liquidity,
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  Speaker 3: which means you're asking a market maker to give you
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  Speaker 3: a bit ass spread. So the vast majority of that
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  Speaker 3: bidass spread is simple to understand.
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  Speaker 4: What would it cost you as.
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  Speaker 3: A trader to acquire or dispose of that basket of securities.
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  Speaker 4: And so for example, if.
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  Speaker 3: I'm trading the triple levered Zimbabwe bitcoin swaps, well my
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  Speaker 3: bidass spread might be ten percent wipe. Where if I'm
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  Speaker 3: trading a basket that's S and P five hundred stocks,
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  Speaker 3: even though the ETF maybe never trade, but once a year,
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  Speaker 3: we could trade a billion dollars of that ETF with
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  Speaker 3: a couple basis points of impact.
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  Speaker 4: So it just depends on the underlying basket liquidity.
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  Speaker 2: You may notice I didn't ask an obvious question, Hey
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  Speaker 2: do you go ETF structure or not? I think we
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  Speaker 2: all understand the advantages of this structure not only intra
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  Speaker 2: day liquidity but no phantom capital gains tax is. But uh,
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  Speaker 2: what might send us in a different direction an SMA
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  Speaker 2: and mutual fund to trust? When is an ETF really
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  Speaker 2: not the right structure?
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  Speaker 4: Another great question? So ETFs.
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  Speaker 3: Unfortunately, we run ETF architects, so everything should be an
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  Speaker 3: ETF of course, right.
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  Speaker 4: But you know, let's be honest here.
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  Speaker 3: The big disadvantages of the ETF structure are transparency and
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  Speaker 3: you cannot close an ETF. So if we have a
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  Speaker 3: strategy where transparency is just not you know, going to
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  Speaker 3: play favorably for my shareholders because I don't expose this
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  Speaker 3: to the world every single day, then obviously you can't
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  Speaker 3: do an et for all intense purposes. The other one
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  Speaker 3: is capital constraints. So let's say we're trading the microcap
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  Speaker 3: strategy and penny stocks, where the maximumount of capital that
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  Speaker 3: can go in there is called fifty hundred mil. Beyond that,
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  Speaker 3: I'm gonna start blowing the whole concept up. You cannot
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  Speaker 3: stop or close an ETF F, whereas an SMA or
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  Speaker 3: mutual fund obviously they have tools in which you can
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  Speaker 3: actually capacity constrain the capity you take on.
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  Speaker 2: So the last question, we have noticed just a tremendous
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  Speaker 2: amount of flows are going to the Big three. They
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  Speaker 2: go to black Rock, they go to Vanguard, they go
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  Speaker 2: to State Street and broad passive indexes have dominated a
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  Speaker 2: lot of the flows. The exception has been these kind
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  Speaker 2: of new, clever, unusual active funds that occasionally catch people's fancy.
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  Speaker 2: If you're thinking about creating an ETF, what sort of
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  Speaker 2: space should you really be looking in? What sort of
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  Speaker 2: strategy is the best ETF alternative to the core of
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  Speaker 2: a lot of people's portfolios, the big indexes.
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  Speaker 3: Yeah, so I would basically focus on things that Vanguard
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  Speaker 3: or I shares can't do well. You can usually going
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  Speaker 3: to be very boutique, very niche strategies where it takes
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  Speaker 3: some special expertise to put those portfolios together, and or
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  Speaker 3: you can't jam a trillion dollars into the strategy, right,
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  Speaker 3: So basically focus as be good at being a boutique
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  Speaker 3: because you're never going to beat Vanguard at delivering scale
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  Speaker 3: trillion dollar market beta. That's insanity. So anytime you have
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  Speaker 3: a strategy that the Vanguard is not offering because it's
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  Speaker 3: either really complex, really differentiated, hard to explain, hard to build,
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  Speaker 3: hard to manufacture, or there's just not massive scalability, that's
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  Speaker 3: where you'd want to focus. If you can put a
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  Speaker 3: trillion dollars in your strategy without any breaks, it's probably
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  Speaker 3: not going to work because Vanguard's already doing it, and
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  Speaker 3: we don't want to compete with the monopoly.
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  Speaker 2: So so to wrap up, if you're an analyst or
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  Speaker 2: a strategist or even fund manager, and you have a
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  Speaker 2: unique idea that you think will do well in the
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  Speaker 2: market as well as well in the marketplace, you think
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  Speaker 2: others are willing to pay for it with their capital,
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  Speaker 2: consider launching your own ETF. You need about twenty five
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  Speaker 2: million dollars in assets and a cost of about a
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  Speaker 2: quarter million dollars annually, but the upside are potentially hundreds
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  Speaker 2: of millions or even billions of dollars in client assets.
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  Speaker 2: I'm Barry Rudolts and this is Bloomberg's at the Money.
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  Speaker 3: Mister