So you have your investment strategy for an ETF (Exchange-Traded Fund), you have a trust to launch the ETF as the advisor, and you are ready to go from an ETF servicing and distribution standpoint. Your key consideration now is whether you need a sub-advisor to manage the ETF on a day-to-day basis.
Asset managers are fortunate to have a number of fund structures to choose from to launch their various strategies, either within active or passive constructs. As ETFs have gained in popularity with investors for their low cost, tax-efficient, transparent and tradeable structures, asset managers have increasingly concentrated on the ETF wrapper for their new product launches. While the basic blocking and tackling of ETF management is very similar to other fund structures, managing a product that simultaneously trades on a listed exchange presents many new challenges for asset managers that may require additional expertise.
‘That’s in my Wheelhouse’
Most asset managers already have the pipes and people in place to manage various fund structures from a portfolio management and trading perspective. An order management system (OMS) that houses the portfolios and rebalances them is typically universal across fund structures. Trading the holdings in the portfolio and settling the trades is also a fairly familiar task across fund structures. When managing an ETF, however, this operational workflow may often times necessitate more specific requirements for asset managers to understand.
‘That’s not really in my wheelhouse’
The beauty behind the ETF structure is its ability to transact with brokers (APs or “Authorized Participants”) with in-kind creations and redemptions for inflows and outflows. For this reason, the ETF issuer, or asset manager in this case, needs to publish a basket on the fund on a daily basis so that APs know exactly what they need to deliver into the ETF for creations, and what they’ll receive out of the ETF for redemptions. The basket process can vary by ETF holdings (strategy), active or passive (style), and for transparent or semi-transparent ETF structures. More specifically, based on the ETF structure, strategy, or style, the basket may need to be a pro-rata slice of the portfolio, a non-pro-rata slice of the portfolio, or even a proxy (correlated) basket to the actual portfolio. Knowing how to construct a daily basket to maximize tax-efficiency for the ETF is very important to minimize taxable capital gains distributions out of the fund at year-end. In addition, it may be critical for the OMS to be on a trade-date accounting cycle to properly manage the basket and tax-efficiency components. This may not be something the asset manager has experience doing or is set up operationally to handle.
Another area within ETF management that may not be familiar to asset managers is the capital markets function. It is important for asset managers to understand that while investment strategy and process is crucial, the overall product’s success also depends on its tradability. Strong relationships and consistent dialogue with APs and LMMs (Lead Market Makers) is key to a successful ETF. This starts by organizing the seed money at launch to ensuring the ETF trades in a fair and orderly manner for clients on a daily basis thereafter. Since an ETF trades on a listed exchange with a bid and ask price set by LMMs and APs, it is imperative that these partners fully understand how to price the basket and, if applicable, utilize the published IIV (Intraday Indicative NAV, Net Asset Value) on the fund. Naturally, the capital markets role needs to ensure that the daily IIV calculation agent is publishing the correct values. For some ETF structures, strategies and styles, the capital markets function will liaise between incoming AP activity and the resulting trading requirements by the fund. Ultimately, the capital markets person is instrumental in helping clients achieve better execution on the ETF and keeping the APs and LMMs informed of what they need to trade it. This, too, may not be something an asset manager has experience doing or is set up operationally to handle.
‘Subbing in a Sub-Advisor’
While some asset managers have the experience and knowledge to build out these ETF capabilities in-house, many asset managers may not. Perhaps they’ll want to call on a sub-advisor to handle any or all of the ETF management pieces, including the OMS, trading, settlements, basket creation and capital markets functions. A sub-advisor may also make sense from a compliance standpoint if running the same or similar strategy within different fund structures or trusts—trade rotations, crosses and best execution may be more complicated given fund sizes and styles, where a sub-advisor can remain completely unbiased.
The investment business is not a game of trial and error when it comes to ETF management. Real money is on the line every day for APs, LMMs and clients when trading an ETF, and the information that the ETF issuer releases to the market has to be verifiably accurate for the utmost integrity of the product. This starts with the basket file and ends with the capital market's role to ensure every client and partner understands their daily risks before and during market hours. Without the experience of managing this daily process, asset managers may risk a great strategy within a bad product. A sub-advisor can help bridge that gap, and SS&C ALPS can provide that expertise for you.
Want to learn more about the new active ETF wrappers? Read more in the SS&C ALPS "Semi-Transparent Exchange Traded Funds: A Revolution in Active Management" whitepaper.
Learn more about our ETF Services by calling +1 617-686-2346 or contact us.
Asset Management, Wealth Management