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March 10th, 2011 by

How to launch your own ETF

With all these ETFs flying around, we as investors have pretty good pool to pick our investments from. In fact, there are even more ETFs coming along. Is that good or bad? Basically this is good, because it gives us more choice.

Now what if you are an investment shop, that has a good strategy and wants to take it “public”, meaning making your strategy available to retail investors. I believe creating your own ETF would be a way to go.

Easier said than done of course, but below is a very brief approach on how to do this. Here is my list of things to consider: Business Plan, Strategy, Service Providers, Registration and Compliance, Marketing and Sales.

Business Plan

As with any new business a business plan is in order. Launching an ETF will not bring you big bucks right away and you have to think the with long perspective. You have to create a budget and find a capital source, either internal or external.

The next thing you have to decide is the management fee you will charge. Typically ETFs range from 20 bps to 150-170 basis points of the Assets Under Management. This part is actually more of an art than science, you have to “charge” for the amount of management work that you do. 150 bps management would be completely inappropriate for a large cap indexed long only fund, but on the other hand if you are an active manager and have a significant short component of the fund, you can certainly be on the top range of the fees – you are creating lots of value.

Strategy

This is a classical marketing exercise, as you need to figure out what strategy are you going to offer. I presume that you will be managing an active portfolio and not an index. Then the questions to be asked are, what do I focus on, equity or bonds or commodities or something else? Is there anyone else who does something similar? Is it large cap or mid cap or small cap?

Once you are there, the next question to ask is, who are my competitors. You certainly don’t want to be another gold fund or an oil fund, they beat you to the market, but what about an absolute return strategy for example, there aren’t too many of those around.

If I want to summarize the strategy section, it would be what kind of value can I provide to the market place that is differentiated from  providers.

Service Providers

Running an ETF is a major administrative challenge. Either you and your team can do it yourself or you can’t. Here I would focus on what you are good at, most likely you are good at managing money, but if you need to hire a large team to administer the fund, it’s just simply better to outsource non-primary (i.e. non money management) tasks.

Registration and Compliance

Now that all those tasks are behind you, you get to work. An ETF is a publically traded vehicle that operates under the Investment Company Act of 1940. The act’s purpose is “to mitigate and… eliminate the conditions… which adversely affect the national public interest and the interest of investors” and that means that the government is watching you. This is not necessarily as bad as it sounds as you start operating on a higher level of scrutiny and hopefully higher level of quality service for the investors.

But practically speaking you need to file a Prospectus with the SEC and this is a big deal. The Prospectus talks about the fund, strategy, principals, how you will trade, basically everything associated with the running the fund. Once the Prospectus is accepted, you have to register with the SEC (not on the State level). This would be a good time to think about your compliance procedures and hiring or designating a Chief Compliance Officer.

Marketing and Sales

So you made it and you are ringing the bell on the stock exchange during the launch of your fund, you have to get to the basics of marketing, educating, promoting and hopefully selling the fund.

Well that’s it, you are ready to go, it’s “that simple”. Actually this a major piece of work for you and your team, you need to seriously think if you want to invest the time and money to build this business. It will take tom become successful, but the ETFs are the way of the future. If you do and are ready to go I would suggest to read several good books about ETFs and how to start one. I like books by Melinda Gerber and Richard Ferri.

Good luck!

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