The ETF industry has been around for over 20 years at this point, but over the past 5 years the ETF industry has captivated the investment world. I’ve had a front seat on the action, launching over 650 exchange traded products while I was an associate at the NYSE in the Global Indexing and Exchange Traded Product Group. We built indexes for ETFs, participated on weekly calls with the SEC trying to get approval for innovative ETFs that fell outside the standard rules, and guided new ETF issuers through the whole process. It was here that I learned one important fact of a new ETF: You, the financial advisor, will never see a bad backtest for an ETF. If the investment idea had a poor backtest, it didn’t make it to market.
I transitioned to RevenueShares to be their Head of Capital Markets, which we grew from $450 million to $1.1 billion and was eventually sold to the mutual fund giant, Oppenheimer Funds. During my seven years in the industry I’ve witnessed that some industry players were prepared, some were caught flat footed, and some are still trying to figure out what to do next.
In this piece, Wes asked me to share some insights on the ETF industry and where it might be heading based on some trends I’ve witnessed. I’ll start this essay with a recap of recent merger and acquisition activity in the ETF space, then discuss why advisors are back in the driving seat, mention briefly some trends in ETF product development, and end with some discussions of what we could expect going forward.
ETFs Create Disruption: Do You Buy Your Way Into the Business?
In 2014 and 2015 there was a wave of ETF company acquisitions by large asset management firms. The reason was simple: if an asset management company was not in the ETF game, they realized they really needed to get in it. ETFs were not a fad that was going away.
Asset management firms had two options:
- Build the ETF division of their firm from within
- Acquire an ETF company and its existing team and/or ETF products.
Some asset managers chose option 2: IndexIQ was acquired by New York Life. Janus bought VelocityShares. Oppenheimer Funds bought RevenueShares (full disclosure: my former employers). Hartford Funds acquired acquired Lattice Strategies. Columbia Threadneedle bought Emerging Global Advisors. Victory Capital acquired Compass EMP.
If you’re a big asset management firm acquiring a small ETF firm, you want to lever your strengths (your brand, large distribution force, and large amount of capital). You need to acquire an ETF company that enables you to do that. The sweet spot for an acquisition is an ETF company that is small enough in assets under management (AUM) that it isn’t an impossibly steep price, yet large enough in assets that your firm has a head start on distribution and marketing. Combine that sweet spot of assets with a decent length of time for their ETFs track record, and you have a company that is an ideal acquisition target.
If you examined the list of ETF Companies in the U.S. at the start of 2014, there was a decent number of acquirable firms in that AUM and track record sweet spot: ~$500 million?—?$5 billion in AUM and three to eight years of track record.
At the start of 2017, the ETF landscape looks very different for potential ETF company acquirers.
Looking at the ETF league table from ETF.com, let’s categorize all the ETF product lines/companies that have over $1 billion in AUM. I’ll use some very official divisions to categorize why they’re either totally not acquirable or near impossible (A.U.M. numbers below as of April 5, 2017).
The “You Can’t Buy Us, but Maybe We’ll Buy You” Division
- BlackRock?—? $1.082 Trillion
- Vanguard?—?$681 Billion
- State Street?—? $531 Billion
- Invesco PowerShares ?—? $120 billion
- Charles Schwab?— $69 Billion
- Guggenheim?—? $35 Billion
The Privately Owned/Unicorn Division:
- First Trust?—?$46 Billion
- VanEck?—?$36 Billion
- ProShares?—?$27 Billion
- Direxion?—?$12 Billion
- U.S. Commodity Funds (technically publicly traded, but a unicorn)?—?$4.2 Billion
The “Already Acquired By, or Started By, a Larger Wealth Management Firm” Division
- ALPS?—?$14.5 Billion
- Deutsche Bank?—?$13.8 Billion
- Northern Trust?—?$13.4 Billion
- PIMCO?—?$13 Billion
- UBS?—?$7 Billion
- Barclays Capital?—?$6.6 Billion
- Credit Suisse?—?$3.6 Billion
- ETF Securities (has one of the largest European ETF businesses)?—?$2.4 Billion
- IndexIQ (acquired by NY Life)?—?$2.4 Billion
- OppenheimerFunds (acquired RevenueShares)?—?$2 Billion
- Victory Capital Management (acquired Compass EMP?—?$1.3 Billion
(This division is interesting because you *could try to convince some of these firms* that a spin off of their ETF business would enable it to achieve its full value. We’re assuming that’s too complicated and these firms want to hold on.)
The “We Started Later, But Are Choosing To Go It Alone” Division
- Fidelity?—?$6.2 Billion
- JPMorgan?—?$5.3 Billion
- Goldman Sachs?—?$3.3 Billion
The “I’m Kinda Seeing Someone Already” Division
- Global X (partially owned by JPMorgan)?—?$4.7 Billion
The Exemptive Relief Division
- Exchange Traded Concepts?—?$2.6 Billion
- ETF Managers Group?—?$1.2 Billion
- AdvisorShares?—?$1.1 Billion
- Millington Securities?—?$1 Billion
The Wisdomtree Division
- Wisdomtree — $42 Billion
(Can they be bought? Yes. Will they be bought? They’re often thrown around as a target acquisition for one of the behemoth asset management firms, but likely too large and too expensive now.)
- That is every ETF company/product line that has over $1 billion in assets. None of them are really acquirable. Yes, there’s always a price, but any firm that can buy the firms above, it probably doesn’t make sense to, and any firm that would like to acquire the firms above, can’t.
Under $1 billion in AUM, we have some very large asset management firms that are either going it alone in building their ETF business line, or they bought a small ETF shop mainly as an acqui-hire (saying this because there was either a short track record for the ETF shop acquired, small AUM, or both).
Since the rush of 2014/2015 acquisitions, the options to acquire firms have become much slimmer. If you’re a firm that is looking to buy your way into the ETF space then, what are the best options from what’s left?
Here’s the list of firms under $1 Billion?, but over ?$200 million in AUM (in millions):
This is a good range to focus on as these firms are large enough to be of interest to a larger firm, or soon could be.
Within those, there’s three independent ETF shops to keep an eye on:
- Pacer Financial
- O’Shares (FQF Trust)
Beyond falling in that AUM range, each of them has a product suite that achieves the following:
- Can handle a large capacity of assets due to how they’re structured
- Their products can be sold in major portfolio allocation segments
- They each have a product suite that has a theme to them that could be expanded upon by a larger firm for future product development.
Those are the key things to look for if you’re considering acquiring your way into the ETF business.
Sure, they each have some flaws in an acquisition scenario (Pacer’s Trendpilot products are more complicated to sell to the average client, O’Shares has a short track record, and Cambria just raised additional capital). But if they were perfect, they’d already be acquired!
The Initial Plan-ETFs Will Deliver Cheap Beta
In part one, we looked at the state of the ETF industry from a business/acquisition perspective.
How did we get here though, and