Should my midsize RIA launch an ETF? Here's what to know

Thirty years ago, State Street Global Advisors launched the first exchange-traded fund (SPY). Since then, investor interest has exploded. ETFs took in more than $11 billion in assets in August, bringing their year-to-date inflows to nearly $285 billion, according to Morningstar. 

As a result, RIAs have become increasingly interested in launching their own ETFs. But there are challenges to consider, chief among them the expense involved. Seed capital for a plain vanilla fund has been pegged at $2.5 million at a minimum, and depending on the fund's structure, registration costs could run anywhere from $100,000 to $500,000.  

In this, or any, market environment, there is no way to know if a new ETF will grow an RIA's assets under management. A successful launch hinges on the product idea and the overall health and stability of the economy. Right now, there are a lot of inhibitors to new ETF products, including an economy many view as questionable and a crowded field of new entrants. 

One positive indicator would be prior success in managing funds, particularly for actively managed strategies. The trend of mutual fund conversions has led to large RIAs introducing existing programs as ETFs. As the industry moves to more actively managed and esoteric strategies, it becomes harder to predict future success. Expect the process to be an arduous one that will require time, open dialog, honest thinking, data crunching and patience. 

Here are some considerations as you plot your way forward.  

Nail down your value proposition
Although large firms have the advantages that come with scale, they can be slow to react to new opportunities — which means there is room for midsize RIAs to succeed in this field. Players and service offerings in the market, like white label ETF firms and third-party providers, can allow a nimble operator with a distinctive idea to move to market quickly. The most important thing to determine is whether your idea will have the ability to stand out and go the distance in a crowded field.   

In deciding on a theme, beware of a herd mentality that can make a segment of the market appear more important than it might be. For instance, the expectations around bitcoin ETFs were high but proved difficult to sustain in a crowded (as expected) field of competitors, and it's been the same with AI-themed ETFs. But while it can be a gamble to follow what's hot (cannabis ETFs also come to mind), it's important to stay away from truly outlier ideas (some politically oriented/themed ETFs come to mind). Timing matters as well. Robotics ETFs, for example, were range-bound for several years before they broke out. On the other hand, there were ETF launches that seemed like layups that have faded over time. 

Have a sales and distribution plan
As mentioned above, white label firms and third-party providers can provide front-to-back operational support for your ETF. But the wholesaling function remains an uphill climb for new issuers. Without an existing asset base, there is no shortcut to AUM growth. Simply put, assets bring in assets, so starting out with a strong partner that can help with sales and distribution, and that has good relationships with small and large wirehouses, is helpful.

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To see if there is interest in your idea, review a portfolio of products and determine if it would be appealing to banks or insurance providers that want to get into the ETF space. Established indexes and broadly known benchmark products have been addressed, so expect new themes to come with some educational baggage attached. More complex or esoteric strategies, such as semi-transparent, actively managed or derivative-focused strategies are being released with ETF wrappers, and the providers must be prepared to educate investors on new ideas and techniques, which takes time and money. Therefore, floating the idea to outside and trusted entities, such as banks and insurance providers, could help launch an ETF into the market.

Ultimately, there are no shortcuts. Deciding whether or not to launch an ETF firm requires significant research and collaboration with industry experts. It's a decision no firm or advisor should come to lightly.