Debunking the Myth of Control
The ETF space is an exciting and ever-growing one, creating plenty of opportunity for issuers and investors. When considering the creation of an ETF, it is important to understand the multitude of avenues available for launching these funds – a key factor being the distinct roles played by advisors and sub-advisors. The following exploration offers a shortcut explanation for those navigating this path. Let’s dive in.
Owning the Trust vs. Advisor vs. Sub-advisor – The Tradeoffs
There’s a prevailing notion that being an advisor is better than being a sub-advisor in the life of an ETF. From a semantics standpoint alone, the words suggest hierarchy and the difference between them is often interpreted as suggesting different levels of control.
Control of what? That’s a great question, and it depends on whom you ask. To some ETF entrepreneurs, it’s about running it all (Trust included). To some, it’s about day-to-day decision-making. To some it’s about brand dominance. Talk to two ETF entrepreneurs, and you probably wouldn’t get the same answer, but you often get the same concern “Can someone fire me or take control of my ETF?”
In reality, the path to ETFs isn’t one-size fits all. Choosing to be an advisor or a sub-advisor ultimately is the same thing in terms of “control” unless you own the Trust. Both advisors and sub-advisors can get “fired” from a fund for breach of contract or fraud. Neither advisor nor sub-advisor would lose the economics of their fund (costs and profits) if ousted because those terms are dictated in a “platform services” agreement. The experience is similar, but the costs and responsibilities are not.
Consider three paths to launching an ETF:
- DIY the whole thing as an Advisor who owns the Trust
You have an ETF idea, you own it, and you want total control. You can do it all yourself as the advisor, building your own infrastructure. That means you must own the Trust, which would probably come with at least a $200,000 startup cost, months of work, and about $350,000 a year of expenses thereafter. Operating as an advisor with ownership of the Trust provides the potential for significant influence over the board of directors; you’d own all the economics, and you’d be on the hook for all the operational headaches – staff, processes, insurances, fiduciary requirements, legal reviews – risks and responsibilities. You’d be on the hook for it all.Perhaps the biggest pro of this approach is control. The con is clearly cost and time. You may also potentially lack benefits of scale, which could be key to access wirehouse/broker-dealer distribution. - Be an Advisor who uses someone else’s Series Trust
You want to be an advisor, but you don’t want to own the Trust, so you use someone else’s. For you, that means fewer external expenses (associated with the Trust) but plenty of internal costs. You’d be responsible for a lot of operational tasks such as reporting to the board, compliance, trading. As the advisor, you’d have to have your own board reporting, accounting, vendor management, capital markets relationships, trading systems, fund compliance system, and lead market makers.You wouldn’t have control over the Trust – and its trustees – but you would still have to handle all the operational work of the day-to-day life of an ETF. The pro is it would cost you less than doing it all yourself – probably around $190,000 a year – but the con is your workload is massive for no perceived benefits of control. You may also not be able to benefit from scale and lower aggregate fees depending on the Trust arrangements.If you are an advisor to a Series Trust, you are responsible for all the expenses of the fund, but you keep the profits after fees. - Be a Sub-AdvisorYou could be a sub-advisor, partnering with a white label provider like Tidal Financial Group who owns the Trust and offers a stack of operational services. With a white label provider, you can benefit from scale and lower aggregated fees. You’d still be looking at the cost of running an ETF that nears $240,000 a year, but profits after fees are yours based on your platform agreement. In this scenario you are responsible for the active management and raising the assets, most of the operational and fund compliance tasks are handled by the service provider.
Unique to ETFs
The role of a sub-advisor can be confusing to those new to ETFs since it is very different from the way the term is used in the Mutual Fund world.
There are two types of sub-advisors:
- the active sub-advisor who is the brand and face of the product,
- the execution sub-advisor who handles portfolio managements, trading, and capital markets.
In a white label context, like the one offered by Tidal Financial Group, you could frame the difference as between being a client or a service. A new issuer acting as an active sub-advisor is similar to how things would work in the Mutual Fund world, but the economics and ownership of the revenues are not based on the role of sub-advisor, but rather the platform services agreement.
The second concept of a sub-advisor for ETFs is the service of handling trade execution, basket management, heartbeat trades, and capital markets. This is unique to the ETF world in that it requires systems and relationships that are expensive and hard to curate. Tidal Financial Group has this service in-house.
ETF Biz Models
Outside of owning your own Trust, both advisors and sub-advisors face similar operational and cost hurdles to entering the business.
What really matters is the contracts put in place – the platform service agreements. Agreeing to be the advisor or sub-advisor without an iron clad platform agreement is a mistake.
The process of launching and managing an ETF isn’t universal, and it involves a range of operational work, staffing needs, and cost considerations. Define what’s important to you, choose your model, partner up wisely, and read the contracts. Do that, and operational success should follow your ETF journey!
