How Much ETF Infrastructure Do You Really Need?

ETF Infrastructure Is Not One-Size-Fits-All

The ETF industry has made it easier than ever for asset managers to enter the ETF market.

For some firms, a turnkey or white-label platform is the logical choice. These platforms can provide the infrastructure, operational support and ETF expertise needed to bring a strategy to market without requiring the manager to build those capabilities internally.

But not every asset manager starts from the same place.

An established investment manager may already have experienced portfolio managers, a trading desk, compliance and operations teams, and relationships with custodians and other service providers that support ETFs. In those cases, the question may not be how to outsource an ETF business. It may be how to adapt the firm's existing infrastructure to support one.

Start With What You Already Have

Before deciding how much ETF infrastructure to outsource, managers should first take inventory of the capabilities already inside their organization.

Portfolio management doesn't suddenly become a new function because a strategy is offered through an ETF. Neither does trading, compliance or many aspects of fund operations.

What does change are the ETF-specific pieces.

Creation and redemption activity needs to be understood. Basket processes need to be established. Authorized participants and market makers need to be engaged. Exchange relationships need to be managed. Trading desks need to understand how ETF activity interacts with the portfolio. Someone needs to monitor how the ETF trades in the secondary market after launch.

Those are meaningful responsibilities, but they don't necessarily require rebuilding the entire organization around them.

The Complexity of the Strategy Matters

The appropriate model also depends heavily on the ETF itself.

A manager launching a relatively straightforward ETF holding highly liquid U.S. equities may have very different needs from one launching a strategy involving derivatives, less-liquid securities, international markets or more complicated creation and redemption baskets.

Consider two managers entering the ETF market. One is launching a transparent ETF holding seven of the largest and most liquid U.S. stocks. The other is launching a strategy using managed futures or an options overlay.

Both are ETFs, but their capital markets and operational needs can be very different.

If your portfolio consists of seven highly liquid stocks, do you really need a separate organization actively managing the basket every day? Your existing portfolio management and trading teams may already have much of the expertise needed to manage those securities.

A managed futures strategy or an options-based ETF can be a different story. Derivatives introduce additional considerations around trading, hedging, valuation, collateral, basket construction and creation/redemption activity. In those cases, additional ETF-specific infrastructure and expertise may provide considerably more value.

The point isn't that one structure is better than another. The amount of support an ETF needs should reflect the complexity of the strategy.

The more specialized the product, the more specialized support it may require.

That means the right infrastructure should be determined not only by the size of the asset manager, but also by the complexity of the strategy.

The Existing Team Still Needs to Learn the ETF Wrapper

Having the right people and infrastructure in place doesn't mean there isn't a learning curve.

A portfolio manager who has spent years managing mutual funds may already understand the investment strategy better than anyone else. But the ETF structure introduces additional tools and considerations. Creation and redemption baskets can become part of the portfolio management process. Understanding how a custom in-kind basket can be used, when a carefully placed cash-in-lieu position may make sense, and how different basket treatments can support portfolio objectives can add value without changing who ultimately makes the investment decisions.

The same applies to the trading desk. Traders need to understand how creation and redemption activity interacts with portfolio trading, how ETF shares move between the primary and secondary markets, and when basket decisions may require coordination with other parts of the organization.

Even the sales team has a learning curve. ETF trading volume, spreads, premiums and discounts, and the role of market makers can create questions that don't typically arise in the same way with a mutual fund. Understanding those differences can help the sales team have better conversations with advisors and investors.

None of this necessarily means those functions need to be outsourced. In many cases, the existing team can learn the ETF-specific aspects of their roles while having experienced ETF expertise available when questions arise.

And that need doesn't necessarily disappear once the ETF launches. New situations arise as funds grow and markets change. A portfolio manager may want to approach a basket differently, a large trade may require additional coordination, or a liquidity issue may need to be worked through with a market maker or service provider. Having someone who already understands the funds, the organization and its service-provider relationships can provide continuity without requiring the manager to outsource the entire ETF operation.

There Is a Middle Ground

The decision doesn't necessarily have to be between building a complete ETF operation internally and outsourcing virtually everything.

For managers that already have much of the necessary infrastructure, a more targeted approach may make sense.

Keep the capabilities that already work in-house. Continue using established service providers for the functions they perform well. Then bring in experienced ETF expertise where there are genuine gaps.

That expertise can be full-time when the scale warrants it. But for managers with a smaller ETF lineup, it can also be fractional, providing experienced guidance and ongoing support without requiring the firm to build an entire dedicated ETF organization.

Build the Model Around the Manager

White-label platforms have played an important role in the growth of the ETF industry and will continue to make sense for many issuers. Other firms will eventually reach enough scale to justify dedicated internal ETF teams.

But there is considerable room between those two models.

For an established asset manager entering ETFs, the first question shouldn't necessarily be, “Who can build this for us?”

It may be:

“What do we already have, what are we actually missing, and what is the most efficient way to fill those gaps?”

The goal isn't to outsource as much as possible or as little as possible.

It's to build an ETF operating model that fits the organization and the products it intends to manage.

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.