How to launch an ETF

“People see [the] fund’s growing, and people start talking amongst each other,” Sommerville said. “It is pretty critical for an ETF to have that momentum early, in our opinion, rather than having [the ETF] sit at a couple of million dollars for months.”

Sommerville takes nothing for granted when the firm is ready to launch a fund.

“You can’t assume that it’s going to be well received,” he said. “You need to get the word out and you need to talk about it. It needs to be sold no matter what. There’s a lot of choice for advisors and investors.”

Here’s an eight-step guide to launching an ETF:

Step 1: Brainstorm

What qualifies as a viable idea will differ based on the needs and outlook of a particular provider.

Paul MacDonald, chief investment officer and portfolio manager with Harvest ETFs in Oakville, Ont., takes cues from market trends in Canada and abroad.

“A good ETF idea aligns with investor potential needs, offers a unique value proposition and leverages our expertise in high-income generation through covered-call strategies,” MacDonald said. “We evaluate whether there is a clear gap in the market or in our existing product suite. The former will generally result in us starting from scratch and the latter may result in us adapting an existing strategy.”

Observing market trends, such as growing interest in artificial intelligence and cryptocurrency, may lead a provider toward thematic ETFs. Such funds occupy a large portion of the lineup at Toronto-based Global X Investments Canada Inc.

“The ETF is one of the great ways to achieve additional exposure to a topical theme,” said Alek Riley, vice-president and portfolio manager, product strategy, with Global X. “It makes it easy and accessible, empowering investors to invest in their own way.”

But Sal D’Angelo, head of product with Vanguard Investments Canada Inc.in Toronto, said his firm’s quest to fulfil investor needs takes it in the opposite direction of topical trends, noting that Vanguard is a prominent cryptocurrency skeptic.

“We’re getting away from short-term fads. We like a long-term, 10-to-20-year horizon that actually has investment merit to be used in a portfolio by an advisor or an investor,” D’Angelo said.

Few new ideas get through Vanguard Canada’s product-development process, which can take three to six months and requires approval from the highest levels of the firm. The release of the Vanguard Canadian Ultra-Short Government Bond Index ETF in September was the firm’s first launch since 2020, bringing its total offerings to 38 products.

“We won’t launch a product if we don’t think we can be actually best-in-class in the category,” D’Angelo said. “We spend more time up front … and hopefully less time in [the] future dealing with products that [we] have to close.”

Step 2: Fine-tune your strategy

The dialogue with prospective investors and financial advisors continues during the product-development process as an asset manager determines which securities will underlie its product and chooses internal or external portfolio managers.

Advisors’ risk appetites are considered early in the process at Hamilton ETFs, Sommerville said. He generally wants products to avoid a “high” risk rating from the Canadian Securities Administrators.

“It just makes it a more palatable product at the end of the day,” he said. “Advisors have limitations as to how much high risk they can have in a portfolio.”

Meanwhile, engaging directly with DIY investors is challenging, but can be rewarding.

“It’s not a huge number of users, but it’s good enough to get some strong intelligence about how the customer base is thinking and what they need,” said Vlad Tasevski, head of asset management, institutions and investors with Purpose Investments Inc.in Toronto. “The onus is on us as asset managers to gather that information and make better decisions for that customer segment.”

Step 3: Call your lawyer

The legal requirements for a new product, including drafting the prospectus and associated documents, are among the most time-consuming and expensive portions of a launch.

Regulatory approval from the Ontario Securities Commission (OSC) need not be a big hurdle, said Jennifer Mersereau, co-founder and co-president of Hamilton ETFs. But time and cost tend to rise in proportion with novelty and complexity.

“I always tell everyone we need to factor in two to three months for relief, but it depends,” Mersereau said.

Regulatory relief can arrive in as little as three weeks, but she leaves a buffer to account for possible staffing shortages and high demand on regulatory resources during the busy season, which occurs prior to the RRSP deadline.

On the upside, Tasevski said, the OSC has a reputation for openness to new ideas, thanks in part to its headline-making approval of bitcoin ETFs — a world first — in February 2021.

“There’s a good dialogue between the industry and the regulator that provides for good, responsible innovation that ultimately benefits the customer,” Tasevski said.

Step 4: Name your price

Investment management and product distribution account for most of Vanguard Canada’s costs in manufacturing a product, and the firm considers other factors when setting a management fee.

“It’s a combination of costs to build, plus competitive dynamics and competitive pricing,” D’Angelo said. “If, on average, the competitors in a certain category are charging 1%, we … could probably do it for lower.”

The markets for passive ETFs are among the most price-sensitive, Riley said. Funds that require active management, such as Global X’s covered-call funds, usually require a higher fee to cover costs.

Providers may be able to charge a premium for unique products, but doing so could invite a new entrant to undercut them.

“Getting there first can help, but to sustain over time, you have to add additional value,” Tasevski said. “Most, if not all, can be commoditized, since there’s no way to protect your innovation. The transparency makes it easy to copy, but that’s a good thing, because it pushes us to get better.”

Step 5: Craft your marketing message

Despite the growth of the DIY market, ETF providers remain dependent on financial advisors for distribution. Still, the message to direct investors doesn’t have to be different.

“We have found that direct investors are becoming increasingly sophisticated,” Riley said, “so it’s exciting to be able to cater to those needs.”

Said D’Angelo:“Our general philosophy is that we can help both segments and usually we try to build a product that can serve both needs. The way we speak to them is different in the level of sophistication, so we try to adjust our message accordingly.”

Step 6: Pick an exchange

The two major listing options are the Toronto Stock Exchange and Cboe Canada, and the choice of ticker symbol should not be taken lightly.

“It turns out a catchy ticker is something that can really contribute to the success of a fund,” Riley said. “It’s a bit of an intangible and it can be hard to figure out.”

Step 7: Prepare to trade

As launch date approaches, ETF providers need to line up a market-maker to act as their designated broker and provide liquidity. This role is generally filled by Canada’s major banks.

Finding a market-maker requires an understanding of the way these firms see their role.

“Some [market-makers] are more interested in being active participants in the market on a day-to-day basis, versus having the option to be able to subscribe or redeem when they have their own internal volume,” Mersereau said. “It varies by broker, but there’s good competition.”

Market-makers could take on more of a gatekeeping role as the saturation point on Canadian exchanges approaches, Mersereau added, noting that some market-makers have declined designated broker mandates from other ETF providers for both quality and capacity reasons.

“They don’t necessarily find the idea compelling,” Mersereau said. “I assume [that] is part of it, as well, as they’re just maxed out.”

Designated brokers also provide seed capital to meet minimum listing requirements, which are typically between $1 million and $5 million, Riley said.

“Occasionally there are larger seed orders, but there is a cost to holding inventory,” Riley said. “As a result, there is generally some pressure to keep seed orders smaller, with the goal being to get out of seed quickly.”

Step 8: Health checkups

The work doesn’t stop once trading begins.

“Post-launch, we monitor trading volume, fund performance and income-generation stability,” MacDonald said. “The most important indicators are the fund’s ability to meet its income objectives, as these directly impact investor satisfaction and long-term viability.”

Things get tricky when risk-adjusted performance metrics fail to translate into growth in assets under management. That’s what happened in the case of a fintech fund run by Hamilton ETFs — the only ETF the firm has closed.

“It was coming up on its four-year anniversary and hadn’t really gotten traction with people, even though it was outperforming all of its relative competitors,” Mersereau said. “We couldn’t see how that was going to change.”

Fee cuts and strategy tweaks can spark a change in fortunes, although Riley noted that material changes to an ETF require unitholder approval.

Riley said he understands why providers are reluctant to close a slow-growing fund.

“There’s an art to [deciding] when you give up on an ETF,” Riley said. The worst case would be to close a fund prematurely, and then see a change in sentiment or market cycle that would have made your product “super topical”; another issuer comes in and capitalizes on the change.

“If you didn’t wait long enough, it’s a painful outcome,” he said. “You’ve got to give it a chance.”

This article appears in the October issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.