Written by: Scott Coey | Managing Director, Head of EMEA Alternative Investment Services Business Development, BNY Mellon
In recent years we’ve seen growing interest from active fund managers to launch ETFs, overcoming some of the hesitation the active management industry has traditionally shown toward the product and the passive investment, index-tracking strategies they represent.
A recent study by EY has stated that within five years, almost all asset managers will offer a passive or active ETF product. As the ‘if you can’t beat them, join them’ mentality takes hold, we’re seeing heavyweight active firms get into the space. However, fund managers have told us that the change in attitude and desire to launch is only the first step, and there are quite a few hurdles that many of them have to jump through internally, within their firms, to actually start the process.
While some of the resistance is foreseeable, even predictable, they are rarely talked about, leaving managers unprepared. Below are three of the most common internal and interconnected challenges managers face when launching an ETF, or other passive products, within an active management firm.
It shouldn’t be a surprise there would be internal pushback against selling passive products within organizations built around active strategies and management – the conflict is very much inherent. There are reservations and client management issues to consider from investors who have long bought into the active products. Active shops further have ingrained cultures built around performance – it’s how stars of the organization are made and how they are paid. ETFs are fundamentally different from that whether it’s the fee structure, the people and personalities, or the process, and require a cultural shift in both recognition and compensation. As an island of passive in a sea of active management, proponents of ETFs have to make the pitch on a strategic level, including why and how they will sell a fundamentally different product, and how that product will ultimately pay for itself.
There’s a built-in conflict to having low-cost passive products in an asset management house historically focused on products with different expense ratios. How do you get the marketing and distribution team to sell an ETF when the incentives are all aligned differently? How will teams willingly divert resources to a new product that some might view more as a threat than an opportunity? Some managers have been able to avoid this internal competition at the start by replacing passive holdings in the firm’s active strategies with the firm’s own new passive products. While this solution provides a stop-gap to avoid wider concerns, the ultimate issue is still whether the passive product will cannibalize sales of more lucrative active alternatives. Fund managers need to focus on delivering the best products for investors to build a sense of equality across all products.
Passive products such as ETFs requires a completely different internal structure to create and maintain, in addition to different resource and infrastructure needs. A lot of additional work needs to be done around building new back-end processes, forming relationships with providers, unfamiliar regulatory requirements, and more. In many instances, these are issues that a traditional active house won’t have experience dealing with, and as alluded to already in the first two points, have the desire or capability to. Generally speaking, an active firm isn’t geared for managing passive products and need a different breed of managers – and in some instances, not a manager at all but a structural specialist. This is a challenge that certain new white label ETF platforms are solving for by providing shared turnkey models, which we discuss in detail in a separate blog post.
As industry thinking around ETFs shift from seeing them as products in themselves to being wrappers for other types of investment strategies, an active house can take the opportunity to launch a carefully thought-out ETF such as a smart beta fund that still stays true to the active spirit of the firm. Presenting the product in this way can help shift the attitude around ETFs and get more internal supporters on board, at least around the idea. Active houses should further leverage their existing brand equity for a leg up against pure ETF competitors, many of whom don’t have the benefit of brand recognition. This is an inherent advantage active managers should be leaning into and cashing in on.