Before You File Your ETF, Read This First

Building an ETF Requires More Than Building a Portfolio

Portfolio managers who come from the mutual fund world know how to build investment strategies.

They evaluate securities, manage risk, monitor exposures, and make decisions based on the investment objective of the fund. When money flows into a mutual fund, the portfolio manager invests that capital according to the strategy.

An ETF introduces another layer.

ETF shares trade throughout the day on an exchange. Market makers continuously estimate the value of the portfolio, manage their risk, hedge their exposure, and provide liquidity to investors.

That means a portfolio can make perfect sense from an investment perspective while still presenting avoidable challenges from a trading or market structure perspective.

For that reason, I believe portfolio managers and product teams benefit from involving an experienced ETF capital markets professional before filing or launching a new fund.

Sometimes relatively small adjustments can make a meaningful difference.

A Different Perspective on the Same Portfolio

During my 17 years as an ETF market maker, I specialized in international equity ETFs, trading funds that invested in virtually every major developed and emerging market around the world.

That experience gave me first-hand exposure to different market structures, currencies, settlement conventions, taxes, and local trading practices. Some markets presented currency restrictions or repatriation challenges.

Others imposed stamp taxes or unique trading conventions, such as round-lot requirements. Some securities traded actively, while others had limited liquidity that could complicate intraday hedging.

These characteristics did not necessarily make a security unsuitable for an ETF.

They did, however, influence how efficiently a market maker could price, hedge, and support the fund throughout the trading day.

Over time, I developed a practical understanding of the types of holdings that tended to create challenges—and those that generally did not.

That perspective wasn't about predicting investment performance.

It was about understanding how a portfolio would function once it began trading inside an ETF.

A Real-World Example

At one of my former firms, the product team asked me to review the proposed holdings of a thematic ETF before launch.

The portfolio included both domestic and international equities. Most of the securities were well suited for an ETF.

A few holdings stood out.

One was located in a market with unique currency and trading considerations. Another traded infrequently and could have created unnecessary hedging challenges for market makers.

The portfolio manager had managed products that I had traded for many years before joining the firm, and he valued my perspective from the market-making side of the business.

After discussing the potential challenges, the product manager and portfolio manager agreed those holdings were not essential to the investment objective and adjusted the portfolio accordingly.

The strategy remained unchanged.

The portfolio simply became easier for market makers to evaluate, hedge, and support.

That wasn't an isolated experience. Throughout my career, I found that conversations between product management, portfolio management, trading, and capital markets often identified opportunities to improve an ETF before it ever came to market.

Mutual Funds and ETFs Create Different Responsibilities

A mutual fund portfolio manager doesn't have to maintain a fair and orderly secondary market.

An ETF market maker does.

Throughout the trading day, market makers are continuously evaluating the portfolio, managing risk, hedging exposure, monitoring currencies, and determining fair value—often while the underlying markets themselves are changing.

Those are not investment decisions.

They are market structure considerations.

That is why collaboration matters.

The Best ETF Launches Are Collaborative

Portfolio managers understand investment strategy.

Product managers understand product development.

Capital markets professionals understand how those portfolios are likely to behave once they're wrapped inside an ETF and begin trading in the marketplace.

None of those perspectives replaces another.

They complement one another.

The best ETF launches I've experienced were collaborative efforts, where each group contributed its expertise early in the development process.

Sometimes the difference between a good ETF and a great ETF isn't the investment strategy.

It's ensuring that the strategy has also been viewed through the lens of someone who understands how that portfolio will trade, hedge, and function in the marketplace.

Disclaimer

Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.