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Yes, mutual funds, trusts and ETFs. Have you ever wondered how these are put together? Are you an analyst, strategist or fund manager that has a really good idea? Have you thought about launching a fund to employ that idea? I'm Barry Ridolts, and on today's edition of At the Money, we're going to discuss how to build your own exchange traded fund or ETF. To how help us unpack all of this and what it means for your portfolio. Let's
bring in Wes Gray of ETF Architect. He helps managers turn strategies into ETFs by providing turnkey, white labeled platforms that handle legal, compliance, operations, portfolio management, allowing sponsors to focus on the idea and distribution. And Wes also runs the Alpha Architect shop as well. Full disclosure, Wes Gray and ETF Architect are helping my firm, Retults Wealth Management launch a new ETF later this year. So Wes, let's
start with the basics. If I'm someone with a novel strategy and a good idea for a ticker, what are the elements that determine whether or not this ETF launches or whether it just dies on the vine.
Well, I think it's going to come down to low fees, capital and passion. In ETF market, as you know, you got to have low fees for the most part, or peep an't going to buy your product, and low fees means you also got to have a lot of capital to back this thing, because you've got to be around for at least three to five years and tell your story, and then you've got to have the passion.
You're in a.
Market competing with monopolies like Blackcroc and Vanguard, So you got to be someone like a per tole that we talked about previously, where you just have to go knock on doors and tell people why your product in your story is so great.
Huh really interesting. So I'm curious as to the timeline from the original conception to trading day. What's the realistic timeline and where are the common bottlenecks.
So we generally tell folks four months you sign the letter of.
Intent and you're ready to whoop it on, we can get this thing out at the door and plus or minus four months. Obviously that could go out to four years. It depended on your own internal issues. But we've got this thing so checklist and automated. At this point, if you want to launch in four months for like a relatively straight forward ETF, that's going to be possible.
Four months seems really short, but I guess I'm imagining how long it takes to accumulate enough seed capital launch. How much money under management do you need to launch an ETF? How does that get structured? What's the usual launch dollar amount?
Sure, so this is a moving target.
And let's say four or five years ago, we would have said, hey, five million minimum. Now we tell people twenty five million, and I'm about to probably move it up to fifty million. And really it's not because of the operating costs of the ETF's to convey.
Credibility to the marketplace.
We need like people just everyone kind of knows, like, hey, where's your break even? You know, because I want you to be in business three to five years from now, and usually that break even in people's minds is twenty five to fifty milis so anyways, high barrier to entry just on that. Ye, Now, how do you see these things? Well,
there's basically two methods. Either seed with cash, so you launch the ETF and people go open up their Schwab account and click the button and you know, pay cash to buyer ETF, or you can seed it with property, where there it's a little bit convoluted, but there's a thing called section three fifty one where you can actually contribute property tax free to seed the ETF. So basically cash or property is the two methods you can use.
And I'm assuming property is usually individual stocks or bonds. Is that right?
Yep, you got it.
So if you have a portfolio of securities public securities that naturally fit in the CTF, you can contribute those tax free and then that that property serves as an initial seed for essentially the launch of the ETF.
So you mentioned break even take me into the minutia of what the back end of this looks like, legal, audit, administration, listing, distribution marketing. What are the big costs that any ETF manager has to run? Where do people kind of make mistakes with these?
So yeah, I'll kind of reverse the question and let me tell you what we've done, the cost and what you have to do, because what you're asking about is a total dumpster fire behind the scenes. But essentially for Our platform is like you show up with the spreadsheet, tell us what to do, and you go market and distribute this thing comma compliantly. Because we have oversight responsibilities.
That's your two primary jobs. Now we're going to deal with all the dumpster fire behind the scenes and the generic cost of doing this to launch an ETF again all sandbag for a generic ETF. Just with easy numbers, you're looking at a fifty k startup, soup the nuts and then, which is not the bad news. The bad news is the ongoing cost to deal with all the aspects you'd just talked about. And you know it's plus or minus, but you're looking around two hundred k year.
So what the heck does that mean as a business setup. Well, you know, if you share one percent, your break even is twenty million. If you charge twenty basis points, which is much more marketable, your break even is one hundred million, and then everything in between. So obviously your break even depends on your fee. But you're looking at two inner k burn a year on average.
Let's say someone comes to you with a systematic strategy. How do they decide whether or not this is based on an index and running it fairly statically versus a more active ETF that's run more dynamically.
So in this advice has also changed over time.
We're in the old days we would say, hey, index active, there's a bigger trade off there. Now it's almost always the case just go active, even if your strategy is one hundred percent systematic. Why is that, Well, there's this low overhead cost. I don't have to pay for a third party index agent. I'm going to pay for third party service providers, and I also have a little bit
more flexibility at the margin. So for example, let's say I'm on an index versus an active and I'm doing the exact same strategy, but we know this week there's going to be three FED meetings and you know the world's going to blow up. I might not want to rebalance this week. I'll just punt to next week. That's easy in an active strategy. In an index strategy, that's possible.
But the paperwork trail and the compliance to be able to facilitate that's essentially a nightmare, which means most index funds just follow the book no matter what on like little minutia decisions like this. So we recommend active at the margin.
So you must see a ton of different strategies. What do you see that really shouldn't be put into an ETF? What kind of strategy even if a manager is passionate and excited about the idea, what are the sort of red flags that, hey, you don't want this in an ETF.
I mean, I'm I don't know if I'm weird or just old school or conservative, but if I'm not going to recommend this to my parents or my grandma, why do we have this in an ETF where anyone with the Schwab account can click the button and have a party.
Right? So what does that mean?
Things like double lever, triple levered Whatever's a lot of these gimmicky products that are extremely expensive and they have tons of embedded costs be like swaps and a lot of other things that aren't transparent.
I can't stand those products personally. Does that mean that people won't do them? Well, of course not.
If you can sell out the people that are gonna pay one percent for your stupid idea, great, But I'm not a big fan of having those products in the ETF marketplace.
So you're not a big fan of the inverse three x levered bitcoin ETF.
I No, I'm not a fan.
Again, maybe I'm just a funny duddy and I need to move on in the world.
But I just kind of old school. I like, you know, low fees, transparent, tax.
Efficient things that people can understand that presumably add value in the long game.
So let's talk about some of the block and tackling. Once an ETF is created and launched, how do you think about what I think about as someone who is on a trading desk as good market behavior meaning tight spreads, reasonable liquidity, especially if the ETF is holding some assets that are perhaps a little less liquid than than average.
Yeah, that's a great question, and it creates a lot of confusion in the marketplace. And so what there are there's basically two types of ETFs. One will call liquidity diamonds. These are ETFs that everyone knows right like spy triple Q or. When you go and transact in those ETFs, it's very likely that you're actually trading shares with someone else who actually owns those ETF shares. That's rare, right,
because it's just such a huge market. The other set of ETFs, which is ninety nine point nine to nine percent of them is normal ETFs where when you go access to marketplace, you're accessing what they call primary liquidity, which means you're asking a market maker to give you a bit ass spread. So the vast majority of that bidass spread is simple to understand.
What would it cost you as.
A trader to acquire or dispose of that basket of securities.
And so for example, if.
I'm trading the triple levered Zimbabwe bitcoin swaps, well my bidass spread might be ten percent wipe. Where if I'm trading a basket that's S and P five hundred stocks, even though the ETF maybe never trade, but once a year, we could trade a billion dollars of that ETF with a couple basis points of impact.
So it just depends on the underlying basket liquidity.
You may notice I didn't ask an obvious question, Hey do you go ETF structure or not? I think we all understand the advantages of this structure not only intra day liquidity but no phantom capital gains tax is. But uh, what might send us in a different direction an SMA and mutual fund to trust? When is an ETF really not the right structure?
Another great question? So ETFs.
Unfortunately, we run ETF architects, so everything should be an ETF of course, right.
But you know, let's be honest here.
The big disadvantages of the ETF structure are transparency and you cannot close an ETF. So if we have a strategy where transparency is just not you know, going to play favorably for my shareholders because I don't expose this to the world every single day, then obviously you can't do an et for all intense purposes. The other one is capital constraints. So let's say we're trading the microcap strategy and penny stocks, where the maximumount of capital that
can go in there is called fifty hundred mil. Beyond that, I'm gonna start blowing the whole concept up. You cannot stop or close an ETF F, whereas an SMA or mutual fund obviously they have tools in which you can actually capacity constrain the capity you take on.
So the last question, we have noticed just a tremendous amount of flows are going to the Big three. They go to black Rock, they go to Vanguard, they go to State Street and broad passive indexes have dominated a lot of the flows. The exception has been these kind of new, clever, unusual active funds that occasionally catch people's fancy. If you're thinking about creating an ETF, what sort of
space should you really be looking in? What sort of strategy is the best ETF alternative to the core of a lot of people's portfolios, the big indexes.
Yeah, so I would basically focus on things that Vanguard or I shares can't do well. You can usually going to be very boutique, very niche strategies where it takes some special expertise to put those portfolios together, and or you can't jam a trillion dollars into the strategy, right, So basically focus as be good at being a boutique because you're never going to beat Vanguard at delivering scale
trillion dollar market beta. That's insanity. So anytime you have a strategy that the Vanguard is not offering because it's either really complex, really differentiated, hard to explain, hard to build, hard to manufacture, or there's just not massive scalability, that's where you'd want to focus. If you can put a trillion dollars in your strategy without any breaks, it's probably not going to work because Vanguard's already doing it, and we don't want to compete with the monopoly.
So so to wrap up, if you're an analyst or a strategist or even fund manager, and you have a unique idea that you think will do well in the market as well as well in the marketplace, you think others are willing to pay for it with their capital, consider launching your own ETF. You need about twenty five million dollars in assets and a cost of about a quarter million dollars annually, but the upside are potentially hundreds of millions or even billions of dollars in client assets.
I'm Barry Rudolts and this is Bloomberg's at the Money.
Mister