BY JOHN JACOBS AND RICHARD KEARY
The Importance of Post-Launch Activities
The ETF BILD Project is presenting this paper to create a dialogue and place emphasis on post-launch activities for new ETFs. The industry has done a commendable job of explaining how to launch an ETF; we want to delve into the important activities that are a must for creating a successful ETF after it has been launched.
Launching is easy, raising assets is more of a challenge and needs further inspection to help those who are seeking to create new ETF products.
We begin by looking at the current state of the ETF industry, followed by a discussion of the important elements of creating a successful ETF including product differentiation, distribution and messaging.
Understanding the Headwinds: The Current State of the ETF Marketplace
“It was the best of times, it was the worst of times…” are the often-quoted opening words of A Tale of Two Cities by Charles Dickens and it accurately describes the current exchange-traded fund (ETF)/exchange-traded product (ETP) ecosystem. The industry continues to enjoy tremendous growth with assets invested in ETFs/ETPs listed globally recently breaking through the $4 trillion milestone at the end of April 2017, according to ETFGI. But while ETF launches were previously strong with 284 in 2015 and 247 in 2016, new launches have slowed: 2017 is on pace for fewer than 200. Yet enthusiasm for industry growth belies some fundamental problems that are already stifling growth – and worse – innovation, an essential ingredient in the success of ETFs.
Taking a deeper look utilizing ETF.com data, we find that for the first four months of 2017, the top four ETF sponsors (BlackRock, Vanguard, SSGA, and Invesco PowerShares) garnered $272 billion in new assets under management (AUM) bringing their total to $2.482 trillion at the end of April. Of approximately $4 trillion in worldwide assets, the top four firms alone have 62 percent of all ETF/ETP AUM. In the U.S., the big three control 80 percent of the AUM.
And then there are other dynamics common to the maturation of a marketplace. Fee compression is reducing margins and creating a larger barrier to entry for emerging managers and the ability for new entrants and new ideas to come to market is becoming a challenge.
There has been a shift in many ETF sponsors to focus more on distribution than on new products. These numbers appear to confirm that trend.
Hindrances to Innovation
Three major interconnected challenges underlie the continued innovation within the ETF/ETP space: distribution, seed capital and liquidity.
First, as previously mentioned, is the concentration of distribution. As we can clearly see from the above statistics, a few large firms and their distribution channels drive the ETF/ETP field. It is increasingly challenging for the small to medium-sized player (or even the lower end of the large player) to compete for shelf space to showcase their products to financial advisors and their customers.
Second, insufficient seed capital hamstrings new product launches. The vast majority of new products have been launched with inadequate seed capital to sustain them through the very challenging market adoption phase. In fact, during the first quarters of 2017 and 2016, sponsors shut down 48 and 65 ETF/ETP products, respectively.
The third concern and directly related to these points is ETF/ETP liquidity, including the liquidity of the underlying constituents. Just as we see a concentration in AUM in the main equity products of the top sponsors, the liquidity or trading in the world of ETFs/ETPs is also highly concentrated.
Lack of liquidity is directly related to a lack of seed capital and a lack of follow-on creation capital. This makes it increasingly difficult for the new, small products from the small to medium-sized firm to get an established foothold in the space. Lack of seed capital combined with the inability to access distribution channels creates a scenario that, despite the headlines, puts the entire business at risk of losing a key source of innovation, the core foundation of the ETF industry.
Why ETF Launches Fail: Post-Launch
Many sponsors feel that launching a new ETF/ETP is the end of the process and all that is needed is a great new idea. They believe that a good idea will sell itself after ringing the bell and enjoying the initial splash and buzz. Nothing could be further from the truth. The hard work truly starts post-launch and requires creativity, proactive marketing and tireless effort to push and pull the product into acceptance and sustainability.
The sobering reality is that the time, money and expertise needed to launch is dwarfed by what is needed to raise assets. There have been many publications, articles and conference panels on how to launch an ETF but post-launch activities often are an afterthought, however; they are critical to raising assets. It’s an action item that needs to happen early in the process as to determine the real opportunity not just for a successful launch but for creating an ETF that attracts assets.
When we see an ETF fail they are usually lacking at least one of the three main components of success.
- Capital – Roughly $650,000 in operating capital needed to sustain an ETF for at least three years (average time frame for an ETF to hit breakeven). This does not include a marketing budget or seed capital. This number is an approximation for new issuers who are using a third-party platform. The costs will be higher if the manager is planning to handle all operational procedures internally.
- Quality Product Idea – Where in a portfolio or asset allocation model does this product fit? Is that space too crowded, too competitive?
- Distribution Plan – How are you going to sell this product and to whom?
The operational capital component is straight forward, either you have it or you don’t. Seed capital is becoming an increasingly larger part of the early success of an ETF. Launching with less than $10 million in seed capital can extend the time needed to reach breakeven and increase the burn rate of your operating capital. This is an important conversation that should be saved for another day.
The quality product idea is much more nuanced. It’s an educated guess as to whether or not the product idea will play out. There is no crystal ball. However, you must look at the competitive landscape and if heading into a direction where you will compete with the big three ETF providers, you may want to reconsider your offering. The use of smart beta indexes has skyrocketed because emerging managers can take their own intellectual property and wrap it into an ETF that differentiates itself from other ETFs.
One of the issues that arises with innovative new strategies is the complexity of those strategies. Simple sells and the successful ETF will have a strategy that investors can easily understand and that advisors are comfortable recommending to their clients.
Developing a Successful Post-Launch Strategy
The distribution plan is the most critical of all the components of a successful ETF. If an emerging manager has an existing relationship with a team of wholesalers or has a track record of raising assets, then the decision process to go or no go on the launch is much easier. But what we see most often is the “let’s build it and they will come” approach to distribution. Well that no longer works in today’s competitive ETF market.
ETFs are no longer bought, they need to be sold. There are many entrepreneurs out there who can build a product that outperforms on a back-tested basis SPY and offer it as a replacement to SPY, but they do not have the distribution capabilities of SSGA. Performance is not the only metric in selling an ETF. You need to be able to reach investors with your investment thesis, and there must be a need in the marketplace for it. There is no need to replace SPY, unless you can do it cheaper.
No magic bullet exists nor do standard operating procedures that will lead an ETF to raising assets, but there is a process that with consistent attention will give emerging mangers the best opportunity at success. Their distribution plan and its execution in the post-launch activities will determine success or failure.
More simply stated, it is operations versus marketing and sales. Operationally there is a check list that every ETF provider goes through to launch an ETF. The marketing/sales side often gets overlooked or sometimes omitted. The provider often feels that the product’s performance will speak for itself, and they most likely will spend their entire capital getting to launch day and no longer have a marketing budget. That’s a problem.
When you review the successful launches of ETFs going back to the original Spyders or iShares or some of the most successful thematic ETF launches more recently, you will find a common thread: strong, concise and compelling narratives. Messaging about the product and the provider (firm) is crucial.
Creating successful messaging starts with taking the time to do the research to ensure you fully understand the needs and fears of your target audiences. That’s the key to distinguishing table stakes from differentiators. Too often, ETF providers lead with the things they are proud of that under analysis prove to be fairly common – investment acumen, a great team and strong capital partners. Those things are crucial, but do not resonate since you aren’t even credible with advisors, investors or financial firms unless you have them.
Employing an Integrated Model
Once you have vetted strong messaging the next step is finding the best ways to reach your audience. Today, that is more complex since more than any other time in history, audiences control the interaction. They have more ways to filter your message out either proactively or simply because of the preferences for communications channels. For example, a 65-year-old may still be reading a print edition of the Wall Street Journal while a 30-year-old may filter news through his or her Twitter feed, not necessarily conscious of the news source.
To break through, firms need to create strong content and promote it as efficiently as possible through as many channels as possible. It sounds daunting, but with the right approach it can be done efficiently and effectively. An integrated or holistic model is an approach that repackages content to create as many touch points with a target audience as possible.
The three stages to move a target to a customer are Awareness; Comprehension; Execution. No one will buy a new ETP (or any product for that matter) unless they know about it, understand it and then feel they need or must have it. There is an ancient saying in business that if you build a better mousetrap, the world will beat a path to your door. That simply is not true. The world has to know you built a better mousetrap, they need to understand why it is better and lastly, they must want or need it. The ETP space is tremendously crowded today and there is a large amount of noise and distraction. The most important activity post-launch is to continue to push the story through every channel possible.
The ETP market is dominated by an oligarchy of indexers; an oligarchy of sponsors; and an oligarchy of distribution channels. Without a strong brand, compelling story and dedicated effort to get that story out over and over again, the chance for adoption of a new product is very slim. Investors and traders need to be aware of your product and how it will help them. After that, the step to comprehension is far shorter and once they understand, the final step to purchase is the shortest of all.
We began with perhaps the most famous opening line in literature; the ending of A Tale of Two Cities is just as applicable to the ETF industry as the opening line. In the novel there was a chaotic ending that led to the belief that the revolution will transform not just the people, but the city of Paris as well. The same can be true with ETFs. As difficult as the landscape looks with the lion’s share of AUM belonging to the big three, there is opportunity and hope that other ETF providers large and small can still compete in this growing marketplace. But those emerging manager’s up for the challenge will need to execute a disciplined approach to their post-launch distribution activities. The right strategy, properly marketed with the right messaging and branding, can put forth a lead to shelf space and success. But it is no longer a ‘throw the fund into the market and let investors find it’ world. Rather, emerging managers must be thoughtful, proactive and put forth a lead to consistent effort. If so, ETF sponsors large and small along with the industry as a whole will find it is indeed the best of times.