ETF Revolution

Bill Arnold  

Good afternoon and welcome to the SEI's podcast series, ETF Revolution, a podcast focused on all things ETFs. I'm Bill Arnold, Regional ETF Director here with SEI. Joining me today are two featured guests, Jennica Ross of Susquehanna International Group and Erin McClafferty of Cohen and Company. 

Jennica is the head of US ETF Sales and Portfolio trading at Susquehanna, which is one of the world's largest proprietary trading firms and a leading ETF market maker. She has worked in the ETF industry for over 10 years and serves as a co-president of the Women in ETFs U.S. 

Erin is a member of Cohen and Company's senior leadership team and co-leads the go-to market efforts for registered funds, including ETFs focusing on strategy and national growth efforts. Erin is currently the co-president of the Women in ETFs Philadelphia chapter.  Jennica. And Erin, welcome to SEI's podcast series and thanks so much for joining me today.

Jennica Ross  

Thanks for having us.

Erin McClafferty  

Really glad to be here. Thank you.

Bill Arnold 

Great. So I thought we would start today by just talking about Women in ETFs organization, what roles you play, how you became involved in it, and just would love to hear your thoughts on where we're going with Women in ETFs.

Jennica Ross  

Yeah, thanks for having us, Bill. And it's great to have the chance to kind of tell the story about women in ETFs. It's just such a fantastic organization coming up on our 10th anniversary now. Which is amazing to think that the 10 years has already gone by, but if you look at the organization today, it's a global organization. We have roughly 9,500 members globally, men and women. And the purpose of the organization is to bring together people to support our mission, which is connect, support, and inspire. 

I think we all know in our everyday life, you're in the weeds of your job, you're in the weeds of your own career trajectory, and you oftentimes don't have the opportunity to meet people who are in our industry but are doing other things, advocating for people that might not be on your direct team.

Finding ways to bring people into an organization that will add diversity, add depth to the perspective that your organization might have, and that's really what the purpose of the organization is, to provide a network and a resource for people to get leadership opportunities to meet people that they haven't had a chance to meet to further their career. And that really is the purpose of what we're doing day in and day out across each of those regions that we're covering.  

Erin McClafferty (02:27)

And I think we all know that we don't progress in our career on our own. That you need Advocates, you need help, you need mentors, and sponsors. For women in particular, I think you need to be able to look up to that next generation and to see really wonderful role models and women who have paved a very significant path, particularly in the ETF space. 

Jennica Ross (02:53)

Absolutely, and I think one of the things that is important for us to do is to kind of think differently about our business. The ETF industry itself has matured significantly, but I do feel like we're at an inflection point that, let's see now where the next 10 years are going to take us.  And through the events that we have, our mentorship programs that we do at the chapter levels, a really wonderful variety of events both in person and virtually that allow people access to information to think differently and to see maybe where their careers are going to go as well as where industry's going to go. Bill Arnold  That's great, and I really appreciate your perspectives on this, but I'd love to actually go back to the start a little bit and figure out how did you get into the ETF industry? And I know I didn't set out to be in the ETF industry, but I'd love to hear your perspectives and where you guys came from as well.

Jennica3 (03:47) 

That wasn't on your college application? Okay, I see. It wasn't on there.  I love hearing people's journeys in terms of how they end up and the role that they end up, the firms that they end up with. I mean, from my perspective out of school, and I've told a number of people, no, this was a politics major, had no intention of even going into financial services, to be honest, had no idea what financial services was, let alone what the ETF world was, but was fortunate, started at UBS at the time in the equity capital market space.  And for me, it was finding people who I respected mentors for people that I appreciated their integrity. I knew that they were intelligent, that they thought thoughtfully about where the business was going. And there was an inflection point, maybe seven years or so into my career on the equity capital market side where there was people that started migrating from more traditional financial services positions into this ETF world.  And it sparked my curiosity. So I started having conversations with them, what are you doing? Why are you doing it? Why are you making a career change at this point in your life? And it really made me think about potentially making a career change, which is what I ended up deciding to do. 

Bill Arnold (04:53) 

And Erin, I'd love to hear your background as well.

Erin McClafferty 

Yeah, it's interesting, similarly to both of you didn't necessarily intend to follow a path into ETFs. I was also a political science major in college, and so had some… 

Bill Arnold 

That a prerequisite? 

Erin McClafferty (05:10) 

Yeah, you have to do a political science. Amazing how many people you meet in this industry who come from a liberal arts background. I see it all the time in terms of managers or other folks. It certainly speaks to, I think, the energy and the innovation and the creativity in the industry as well.  

But I started in a PR firm working in consumer marketing consumer brands, and joined a small accounting firm when I came back to the Philadelphia area from a different city. And it was a boutique firm that was focused on the investment management industry. And I was the first professional dedicated to growth in the small firm. The firm grew to be very much nationally recognized in the investment management space, including with ETFs.  And so as I progressed in my career, as ETFs became more well known, there were more ETFs launching, I was introduced more to the space and have just been so impressed again by the innovation and the energy and also how education forward the space is as well. And so collaborative, certainly room for competition, but it's just been, it's at the end of the day, and I think we've talked about this a little bit, it is all about the people and great people in this space. 

Bill Arnold  

And a great ecosystem. 

Jennica Ross (06:30) 

And I think people don't understand how broad that ecosystem is. We say ETFs are receive financials, but what's actually under the hood? And when you look at that and it's marketing, it's social media, it's portfolio management, it's trading, it's operations. Bill Arnold  Law firms, it's accounting firms. 

Erin McClafferty (06:46) 

It's interesting because I feel like, so I'm coming from 20 plus years now from working in an audit firm as someone who's leading marketing go-to-market strategies. But it's amazing to me how many times people sadly forget that audit and tax is part of the ETF ecosystem. I've even seen very detailed charts of the ecosystem where there's no mention of audit and tax. So that's part of our responsibility too, to share why audit and tax is a really important part of the ecosystem too. 

Jennica Ross  

Please don't forget audit and taxes. 

Erin McClafferty  

Yeah, it's kind of important. 

Bill Arnold (07:21) 

For sure. I'd love to hear your thoughts on how we all can promote future generations of women to join the industry. What do you think and what are your perspectives on just really from a grassroots perspective, bringing more women into the industry? 

Jennica Ross  

One thing that I found very helpful for me personally, and it's sort of happened when I was young and as I started my career as well, is just have conversations with people earlier. I think a lot of times we don't talk about the professional world to girls and boys, all children as they're at that middle school, high school level. The conversations oftentimes start at towards the end of college. And if you think about it, that's so late in the process. 

Bill Arnold  

Seems late. 

Jennica Ross (08:10) 

So starting to increase the conversations, the honest dialogue, what it means, contextualizing what these words actually are. I think it's really powerful. It allows…kids are inquisitive. So if you start discussing some of these kind of components to them, shedding light in terms of some of the really amazing sort of research. And we've gotten pretty creative in terms of the content that we're putting out there. It's fun to read. So if you can share that with people that might be younger in your life, nieces, nephews, children, people in your community, I think that really opens people's eyes up to what the possibilities could be. 

Erin McClafferty (08:44) 

And I think that's why some of the outreach that we're doing from Women in ETFs is so important as well. Going back to universities and maybe at some point even going back into high schools, younger kids, both obviously boys and girls, just to really educate and explain why it is a great career path and how many different options there are, just not necessarily having to stay in one lane, but that there's just so many, there's so much opportunity throughout the trajectory of your career.  

Jennica Ross (09:13) 

That's a good point, Erin. I think a lot of us are fortunate to have had some exposure to professional careers as we were growing up. Even my parents were teachers, school teachers, so I didn't understand sort of what this business world was.  

Being conscientious that those conversations that you're having, especially with the younger generations, you're touching as many people from diverse backgrounds as you possibly can. So that knowledge doesn't continue to reside in one group of people that we're bringing interesting people from all facets of life into this business going to give us our creativity. And innovation that you discussed earlier. I think for this next phase that we're about to embark on… 

Bill Arnold (09:53) 

And I like the point about starting kids earlier. Even my kids, I have two daughters and a son, and I've started to just educate them on what an ETF is. If you can start them that young, they're interested. Now they look at it every day and they say, whoa, this is really fantastic. And they get interested very early on. I think that's an important part of it for sure. 

Erin McClafferty  

We need good girl dads out there.  

Bill Arnold  Yeah, for sure. 

Erin McClafferty (10:19) 

Yeah. I mean, it is clear that I think when you walk into rooms, it is different than it was 20 years ago in terms of the number of women who are at an industry event or in a meeting or whatever. There was a dinner that I attended about a year ago at a fairly well-known midtown restaurant in New York, very popular in terms of corporate groups or whatever. And I was at a table and with a smaller group, and I looked around the restaurant, and I don't know why I was really particularly observing this at the time, but there were groups of men at each of the tables, and I kid you not, each table had one woman sitting there. So it's clear to me, and listen, I'm not saying that that is specifically, they were groups of ETF professionals, but it's clear that they were probably connected to finance and there's absolutely room for more balance and for more input from more diverse groups because again, we've been talking about the ETF industry thrives on innovation and creativity and collaboration, and we need to see that from more groups. 

Bill Arnold (11:31) 

I totally agree. I think it's very important to get a diverse set of perspectives, for sure. So I guess this is a good segue—I would love to hear your thoughts on what makes you successful in the ETF space specifically. Obviously being outgoing in the ecosystem, understanding the ecosystem, but I'd love to both of your thoughts. 

Jennica Ross (11:54) 

Yeah, I mean, from my perspective, I think a couple things that I've continued to try to focus on and stay true to, one, always be honest about what you know and you don't know. You don't need to pretend to be someone that you're not. You don't need to pretend to have an information set or a knowledge base that you don't be inquisitive, learn, take initiative to do that yourself.  

While I think it's on us as an organization to create the framework to bring people in, it's also people's individual responsibility to ask questions and take advantage of resources that are available to them. So I think that's something that I continue, and it doesn't stop at some point in your career. It's not like, oh, I've now moved from a junior to a mid-tier to a mid-tier senior leadership position. That's a natural evolution that should always continue. 

So that's been something that I've continued to focus on and I've mentioned before, but that network of people is just, that is my lifeline. It benefits you in business in terms of information that's going, opportunities on your career. So really spending a lot of time, having a genuine network of people who you can rely on to gut check you, to push you to push you into opportunities that you might not have had before is critical. 

Erin McClafferty (13:09)

Yeah, I very much agree. I think it's really two-pronged. I think it's what you're bringing to the table intrinsically, and then the support that you're receiving from your outside network and your mentors and your sponsors.  But I think one of the most important things that, the most important messages that we can share with women or really anyone is never doubt that there's a seat at the table. It's not unavailable to you. There's never a reason why you shouldn't be there, and you have to have the grit and the resilience to earn that seat at the table. But there is a seat at the table for you. And I think that that's really important, really just bringing a tremendous amount of, again, that grit and resilience, and it's hard, but you do it anyway and you will find success. But where it is two-pronged is we don't do this alone.

And I think we talked about this a little bit earlier as well. And so being in a place where there are mentors and sponsors and people ahead of you who recognize that, yes, you should be at the table, you do bring good ideas to the table, and you do bring value to your organization. It's important to make sure that you surround yourself with those people as well. And that's something that for me, that has been one of the most important parts of my success is the people that I have worked with. And for over the last 20 years, I have worked very hard. It's been very important to me. I've been passionate about the industry and passionate about my own work, but it's also been those surrounding me who have recognized that and who have made sure that my work was recognized and that my ideas were heard and that I could contribute that value. 

Jennica Ross (15:02) 

The one other thing too that I think is important, and it's oftentimes not talked about because it's not in that professional bucket, is especially being a woman in financial services in the ETF space, a career isn't linear. Your personal life isn't linear. And it's not that you need to have this perfect balance all the time about your career and still managing all the things that you have in your personal life, whether that's relationships, taking care of family members, children, fertility, there are financial burdens that are on you. There's a lot that people are bearing.  

And a lot of times, I think we don't have as many seats at the table, so we bury some of those other things that are very big parts of who we are as people, and we project a professional persona, but that other part is never going away. So I think each person sort of recognizing that you don't need to be one or the other, and you can be true to your personal self while having a professional career. That balance concept is always perplexing to me in some ways. Sometimes I feel like I have it, sometimes I absolutely have none of it. And that's just I think how it's going to be. But not denying or pretending that piece of your personal life impacts, your career decisions, your decisions that you're making in your professional career. 

Erin McClafferty  

Absolutely. We're all fighting battles that no one else can see, so yeah. Bill Arnold  For sure. And the reality is a lot of companies are real new to it, and from that perspective, you're almost helping build businesses, and that's a good thing, and it's an exciting thing certainly for men and women. 

Jennica Ross (16:33) 

And put yourself out there too. I mean, I think if you look, I think we're up to almost 57 sponsors at Women in ETFs from amazing companies, all facets of the business, and some of them are longstanding participants in the business. Some are just getting into the space itself. And so have a voice. 

If you're involved in Women in ETFs, reach out to your chapters. Let people know that you're willing to be someone that people can go to, whether it's hiring a new division, they might be hiring someone into a position or just someone that elevates your visibility in the industry. Leverage that network to put yourself out there. Erin McClafferty  That entrepreneurial spirit will take you far. Yeah. 

Bill Arnold  

I think it's a good segue. Can you just explain to people that are listening to this podcast, what they can do to either register for women in ETFs or become a part of it? What's the best way that they can go about doing that? 

Erin McClafferty (17:23) Absolutely. There are really several chapters around the country, and so in many geographies, there's a way to get involved locally and the local chapters—I happen to co-lead our Philadelphia chapter—always looking for new folks to get involved and to bring interesting insight and ideas. So definitely there's ways get involved locally in many different areas around the country, Jennica Ross  And we make it very simple. We have a great website. It is a great resource to go to. It starts as simple as go to that website. There's a free registration. 

Bill Arnold  https://womeninetfs.com 

Jennica Ross (18:02) 

https://womeninetfs.com. Go to that registration page. It's free. When you start that registration process, all that you're going to do is you're going to select a chapter that's closest to you. And we've got, I think, 16 chapters here in the us. We've got chapters globally. I think we're 40 chapters or so around the globe. So find a chapter that's close to you. That doesn't mean that you're exclusively only allowed to attend events in that chapters.  

When you then get through the registration process, select links and get updates from all the other chapters. Maybe you go on business trips to Chicago, you're based in Philly, select Chicago. Next time you're in a business trip in Chicago, go to one of their events and have a chance to meet people that you may have not met before. But it's a really easy free registration process, and then that gets you in the information. And then just show up at events, reach out to fellow members. 

Erin McClafferty (18:46) 

If you're attending any, really any of the industry conferences. We have events at almost every conference, certainly at Exchange, at Inside ETFs, Morningstar, Schwab. We're doing a lot to make sure that we are present future proof. We're making sure that we're present at all of the industry events as well. Lots of different ways to get involved.  And as an organization, we need the next generation of voices. We need a lot insight and help to continue to achieve the mission and the goals that we have. So it's a very welcoming group. We would love to have you involved. 

Jennica Ross (19:22) Always looking for help. If you register, you get involved and you like what we're doing, please reach out to your chapter leadership or us at the national level, and we would love to incorporate you in a role at the chapter level, at the national level. Lots of ways to get involved, not just as a member of the organization, but as in a leadership position as well. 

Erin McClafferty Yep. There is a seat at the table for you. Absolutely. 

Bill Arnold  

Great. Erin and Jennica, thanks so much for sharing your perspectives and insights. We really appreciate your time and expertise.

Erin McClafferty  Thanks so much for having us.

Jennica Ross  Thank you, Bill. 

Bill Arnold  

For those listening, if you have any questions, please direct them to me. My contact details are included on the invitation to this episode. Stay tuned for upcoming episodes in our series. Thanks for tuning in.

Bill Arnold:         Good afternoon and welcome to s SEI’s podcast series, ETF Revolution, a podcast focused on all things ETFs. I'm Bill Arnold, Regional ETF director here with SEI. Joining me today is our future guest, Nicole Hunter, who works for Dimensional Fund Advisors as the head of ETF Capital Markets. Nicole has worked in the ETF industry for over 15 years and was instrumental in helping d FFA bring ETFs to the marketplace. Nicole, welcome to SEI’s podcast series, and thank you so much for joining me today.

Nicole Hunter:   Thank you so much for having me and I am also a big fan of the ETFs, as you know. I think it's been a little longer than 15 years, but, who's counting?

Bill Arnold:         <laugh>? You started very young.

Nicole Hunter:   12. I think I was 12.

Bill Arnold:         <laugh>. Alright, so again, we really appreciate your time.  We've been talking to a number of clients and prospects that are thinking of launching ETFs from existing structures like mutual funds, and we wanted to ask you, since you've, your firm was one of the biggest firms that have done the conversion from mutual funds to ETFs, what are some of those challenges and benefits that you see with launching an ETF by converting from a mutual fund to an ETF?

Nicole Hunter:   It was definitely something to remember. It's one of those highlights of a career that you never forget here at Dimensional.  As you suggested, we converted seven mutual funds into ETFs back in 2021 and 2022, about 40 billion in assets. You know, it was quite defeat. I would say that there's a number of things for those that are considering the space that you should really think about.  And in my mind there's really three main categories of things, clients, I should say clients, clients, clients, but clients being one,  cost and, and taxes. You know, our motivation here at Dimensional as it is with everything is clients first cornerstone of our business. And so when we think about, when we're thinking about converting and we're thinking about the challenges and the benefits, we spend a lot of time with our clients and, and talking to them about the value proposition of the conversion.

Nicole Hunter:   And now these seven funds were all tax managed and all of these clients that, you know, were eager to have the most tax efficient vehicle, and we all know ETFs, through their structure can be very tax efficient. So it seems like an obvious fit, but we didn't stop there.  and this is one of those challenges, right? Not every client can hold securities. Not every client has a brokerage account, for example. And so when you're, you're thinking about the conversion, it's one thing to say, yep, this is the right tax efficiency solution for my clients. It's quite another to say they can actually hold a security.  and so, you know, we did a lot of homework on that. For us, obviously it, it worked our clients, it was a fit they can hold, securities, but if you're, if the funds you're looking at say have split some that can't assume that cannot, you know, what are you going to do is a, is a big challenge that you need to really think through how you're going to handle.  and that was part of the learning curve.

Bill Arnold:         So you're referring to maybe clients that might hold it direct as a fund, but then clients that are in four [inaudible] plans or something like that, that it might be more of a challenge for.

Nicole Hunter:   That's right. The retirement segment as a category is, is something to pay, a lot of attention to for sure.

Bill Arnold:         And you mentioned costs and taxes are also a big component of the decision to do it. Can you just talk a little bit about that as well?

Nicole Hunter:   Absolutely. So thinking about costs, so you know, now here we've gone with our clients, we've gone through the exercise that this is the right fit for them and they can hold the security. The next thing is you, you know, is what is it going to cost to do it?  conversions aren't free and you know, there's, there's some obvious things like the legal fees and the people and the resources you have to deploy.  you know, you need to factor all that in. The last thing you want to have happen is to convert and the, the cost of the conversion outweigh the benefit of the new structure.  and so, you know, we looked at it not only from like, do we need a shareholder or vote is what's the outside council cost going to be all these things. But in addition, what about the actual operations of the conversion itself? The securities and the portfolios, ours were all equities.  and really going with the fine-tooth comb through the understanding anything that might trigger a cost, and understanding that well before we decided to actually converse. So costs, soup nuts, you know, all of all of the different elements are, are very important when considering conversion.

Bill Arnold:         That's great information.  and obviously ETFs, taxes just in general tend to be better for ETFs. And so obviously that was probably a big component of this. You mentioned in your products they were tax advantage products, but even if it was a regular product, can you just talk a little bit about the, the tax side of it as well for Dimensional?

Nicole Hunter:   Yeah, absolutely. I mean, here we'd identified our tax managed solutions as the, as the right fit. So you can imagine if it was a taxable event, that wouldn't be great. That wouldn't be a great outcome, <laugh>. So we know we're spending some time with our tax teams, outside tax council and really making sure that it was not, the conversion in and of itself didn't result in a taxable event. Last thing I want is someone to have to, you know, have an established cost basis that they have to and pay these gains on, that would not be a great outcome. So really, you know, thinking through that was key for us in our decision, to, to do the conversion and, and happy day, right? It was not a taxable event and, and it was a great outcome for our clients.  you know, so when I think about challenges, you know, is it right for the clients?

Nicole Hunter:   What's it going to cost and is there tax implication are main components that we thought about?  but there were some benefits too.  you know, you'd asked me, and so obviously we talked about the benefit for the clients, they wanted it and it was a more tax efficient structure, but also, I mean, like, you know, for an issuer, there's some benefits as well here.  you know, for thinking about distribution of the product, we all know that there's some industry standards.  in order to have some distribution, you need to have a track record three years, for example, or certain AUM m thresholds.  you know, we had a very robust track record with B seven and very healthy asset basis.  while that was not the main reason we converted it was definitely the clients driving it.  there were some benefits, you know, to the, to the issuer as well.

Bill Arnold:         That's some great,  information for folks that are thinking about launching ETFs. And kind of, as a good segue into that, a lot of the firms that we're talking to are just thinking about it. They're processing or doing their due diligence on whether they want to launch an ETF or not. So I would, I would ask you, what are some of the main challenges for providers when they, when they are thinking of launching ETFs for the first time, having a capital markets background. I know the ecosystem is a big part of it, and, I hear people talk about the ETF ecosystem, so, I’d love to hear your thoughts on launching for the first time and, and the, the challenges that come with that.

Nicole Hunter:   Sure.  You know, it's funny, I, in my years doing this ETF thing, I’ve had the privilege to work at very large ETF issues, some smaller ones. And, and now, you know, I'm happy here with dimensional building this amazing top 10 issuer status.  I think that the learning curve is the thing that I see most new entrants struggle with.  you know, there's, there might be some assumption that if you have a large asset management business, that you've got the infrastructure, but to your point, bill, that the ecosystem is something that can be highly, underestimated. And, and to make this real, like, to put your hands around it, it's something as simple of like thinking about the inflows and outflows, right? In a mutual fund, cash in, cash out, it's a well-oiled machine at most firms that have asset management business businesses.

Nicole Hunter:   They know the timing, they have all the infrastructure, and it's seamless. When those firms start to think about the ETF, nature of inflows now flows, it's very different, right? It's securities in and out, equities or bonds, it's, it's a different, you know, you're no longer dealing with clients coming in and out directly. You're dealing with, broker dealers who are authorized and they need to know what the rules are, for inflows and outflows before the market's open.  so that that timing element of when things need to be done in this asset manager is oftentimes very underestimated. And it's like, okay, what are the systems and the people and the risk management that I need to put in place to actually deliver things in, in a new timeline that I never considered before? Can I, can I and company even do that, is an example of that learning curve that I've seen over and over again for new entrance struggle with for sure.

Bill Arnold:         Yeah, and I think when we were discussing this earlier, we were mentioned that education is a big component. Mutual funds have been around for a long time, ETFs, even though they've been around for 30 years, I think we're still relatively new in this space, and it definitely is an educational component, a big educational component. So, you know, as we talk to new prospects as they're thinking about maybe working with SEI, we always talk to them about, Hey, do your due diligence now figure out and start to understand the ecosystem and the timing of things so that when, when you do make the decision that you're at least,  familiar with what, what's going come about as as you think about launching an ETF?

Nicole Hunter:   Yeah, I couldn't agree more. I think that there's, bring your experts in as early as possible, your subject matter experts and some of the resources that I found particularly valuable.  so if you're not doing this, please, please do. <laugh> is that listing exchanges are a wealth of knowledge.  a lot of them, industry veterans repeat the relationship managers there at all three listing exchanges.  you're, you know, those firms that you're talking to for ETF servicing, are going to help you think through some of those timing, some of those processes, some of that new infrastructure that might need to be built out or at least have you evaluate what solutions are, you know, available in the market.  you know, it doesn't hurt to have a capital markets person. I'm a little biased, and, you know, and get the dealer feedback, those authorized dealers. And all of this, of course, alongside engaging your outside council, the sooner that, that you can bring in the experts, I think that the better outcome that you're going to have in bringing your ETFs to market.

Bill Arnold:         So d FFA has been extremely successful in converting mutual funds to ETFs. What would you say are the main reasons that have contributed to that success?

Nicole Hunter:   if you've heard me say it, like our clients of the cornerstone, and it's true, they really did drive the decision. There was a strong demand, and for the US market, for us to have an ETF structure for our investment solutions, we do everything in partnership with our clients. So that's, that's true in our mutual funds, our SMAs and our other business lines.  and so they were helping us decide to enter this space, helping us define the opportunity set and what solutions they wanted to see in the structure. And adding to that, of course, a lot of them were tax sensitive and they really wanted the structure in addition to maybe say, running an all ETF account solution, that many are doing. For us, that was the key. And then in order to do it and do it well, we needed the regulation to change, right?

Nicole Hunter:   Like I, the, the ETF rule in 2019. And, you know, we really couldn't bring the full value of dimensional, you know, our systematic flexible approach that that best of active and passive, that the cornerstone our clients expect. We couldn't do it before the regulation changed. So as soon as that, you know, that that regulation went through, we were very quick, to bring product to, you know, standalone product market, and then you, of course, you saw us do our conversion and, and then, you know, like I say, we've got 30 ETFs now, we've been very busy over the last two and a half years, but it, you know, so for us it was, you know, clients regulation change, and then honestly,  I can't say enough about the infrastructure. So, you know, with the way dimensional is built investment solutions over the years, we have constantly, we're constantly investing in our systems to make sure we can deliver that systematic, flexible trading approach and managing risk, all the elements that you would expect from our firm. So for us to layer our ETF business onto that constantly invested in infrastructure was really compelling, and allows us to scale and allows us to compete again as a, a top tier issuer.

Bill Arnold:         I like what you say about your, it always goes back to the clients, right? That's extremely important. And let's be honest, clients are telling asset managers what they want. So, Nicole, as we close out this podcast here, just wanted to see if there's one piece of advice that you would give to a new entrance that that's coming to the market. What, what should they really think about or what's the most important thing that you can think of for a, a new, new, ETF provider?

Nicole Hunter:   Well, yeah, thanks Bill. I, so you think about ATFs, you want them to work in the best of times and the worst of times. And, you know, markets have been really volatile lately. So having that, having that infrastructure sound is important. That goes back to that education comment that you made earlier. When you think about, well, how do, how do they actually work? From an issuer's perspective, what if you're not getting cash in and out like you do mutual funds, but you're doing, you know,  portfolio of securities, we, or baskets. We like to see a lot of jargon here in the ETF industry. Like, how does it all work and what's the timing? I can't stress enough to do that education as soon as possible. And, you know, bringing in an industry expert, hiring a capital markets person is going to help you achieve that. Make sure you have that stability for your infrastructure so that your ETFs perform as expected in all market environments.  So the last piece of advice to start early, and really focus on that, you know, that education piece of how ETFs work.

Bill Arnold:         Nicole, thanks so much for sharing your perspective and insights. We really appreciate your time and expertise. For those listening, if you have any questions, please direct them to me. My contact details are included on the invitation to this episode. Stay tuned for upcoming episodes in our series. Thanks for tuning in.

Bill Arnold:    Good afternoon, and welcome to SEI's podcast series, ETF Revolution, a podcast focused on all things ETFs. I'm Bill Arnold, Regional ETF Director with SEI. Joining me today is our featured guest, Eric Balchunas, who works for Bloomberg as a Senior ETF Analyst. Eric regularly appears on various outlets speaking about the ETF market and has written some books, including the Institutional ETF Toolbox, and recently a book called The Bogle Effect: How John Bogle and Vanguard Turned Wall Street Inside Out and Saved Investors Trillions. Eric, welcome to SEI's podcast series, and thank you so much for joining me today.

Eric Balchunas:    Great to be with you, Bill.

Bill Arnold:    So I would like to just hear your thoughts on how the ETF industry got started, what was the reason why ETFs took a little time before they started to get bigger and bigger, but would love to hear your thoughts on the genesis of the ETF industry?

Eric Balchunas:    Yeah. Sure. I really noticed ETFs were going to be a big deal about 2006 I was assigned to cover them from a data standpoint at Bloomberg. And as somebody who had written about mutual funds back in my day at Fund Action for Institutional Investor, and I knew mutual funds, when I saw the ETF, I thought this was five evolutionary steps forward, like from a CD to MP3 kind of deal, and I just dedicated my whole career to it. That's how much I knew this was a good structure or I bet it was. I wasn't sure, but boy did that wave break. And the reason I saw when I kicked the tires on ETFs back then and said, "Man, I'm going to be the ETF expert at Bloomberg. I really think this is the tool for the future, the 21st century vehicle," the big reasons are the multitude of advantages.

I said it takes five steps forward. Sort of like when you get an Uber, it's better than a cab for five ways. It's not just one tiny evolutionary step.

Bill Arnold:    Sure.

Eric Balchunas:    So with ETFs, the main thing is they sort of democratize everything easily. It's easy to get an ETF. They're on every brokerage platform. Everybody has access to them, and they bring everything to you with one click. You can do whatever you want. Mutual funds do that a little bit. ETFs also, they trade in [inaudible], so you can get the price you want at the time you want. This is arguably also one of the things people worry about because you can trade, will you trade, but as long as you can control yourself, that's a good thing, I think, that you can trade them in [inaudible], and the other thing is the tax efficiency. This is a biggie for taxable accounts. They rarely give you a capital gains distribution. You're only taxed when you sell.

I think mutual funds should be taxed like that too. I feel like ETFs are the right way, not like a loophole. Mutual funds just have a bad situation over there because when someone leaves a fund, the manager has to sell stocks or bonds to cash them out, and that can create a taxable event. ETF, through the creation redemption process, are able to sort of avoid that, so you only are taxed when you sell, which I think is fair.

Bill Arnold:    Eric, you mentioned creation redemption. Would you please explain a little bit more about that? I know sometimes people have apprehension or they definitely have concerns about it, so I'd love to hear your thoughts on the CRE creation redemption process.

Eric Balchunas:    Yeah, it's like this biblical sounding term. In my first book, I compare it to the flux capacitor in Back to the Future. In that case, it's how time travel happens in the Delorean, this is how ETFs work their magic. I'll break it down very quickly because I have to teach new hires on ETFs, and when I get to creation redemption, over the years, I'd find they fall asleep or their eyes gloss over, and they didn't get it and I get marked up in the review. So I kept trying to figure out how to get them to understand, and here's what I did. I told the story, and I'll be very brief. Nate Most worked at the American Stock Exchange. He's the father of the ETF. And they were looking for some way to get trading on AMEX. And they thought, "Well, what if we get a mutual fund that trades?" And they go to Bogle. He says no.

But over their process of trying to figure out this new vehicle, Nate Most gets the idea that "Hey, if we designed this sort of like a commodities warehouse," which he was the chairman of the Pacific Commodities Exchange and he saw a commodities warehouse live. So in a commodities warehouse, let's say you have a bunch of soybean oil. You go put it in the locker, they give you a receipt, then you can trade soybean oil receipts all day without moving the merchandise or with other commodities. And let's say you get a bunch of soybean oil receipts, and you want to cash it in. You go to the locker, give them receipts, you get a bunch of soybean oil. This is very much easier than trading a bunch of physical stuff back and forth. So all he did was take that concept, and instead of soybean oil, it's the S&P 500 stocks or a basket of bonds.

So that's why SPDR, the first ETF is S&P depository receipts. So I would say ETFs are kind of like a receipt. And the creation redemption handing in the 500 stocks for SPY receipts, no money actually changed hands. That's called in kind. That's why there's no taxable event when an ETF is...

Bill Arnold:    Makes sense.

Eric Balchunas:    That helps ETFs to have greater tax efficiency because it's not money exchanging hands there. Also, like that they eliminate the share class system of mutual funds. You basically get the institutional class fee, which is great. Mutual funds to me are like a regressive tax system. The less you have, the more they charge you. The eight A class is the most, and the I class is the best deal. ETFs are like the I class for everybody. So like I said, there's democratization all across the board. And so what you've seen is a lot of innovation has come here. And I like that it's a big tent. You've got everything from the sort of vanilla, low cost, Vanguard, Bogle side of the tent, which takes in the majority of the flows, and then you've got the wild and crazy stuff, and then everything in between. And now people are putting active strategies in ETF. There's Smart Beta, there's Themes. It is a fun market to cover. I got to say. There's never a dull moment.

Bill Arnold:    Right. So what I'm hearing from you is that the investor ends up keeping full control over their investment decisions. That's what I tend to talk about when I'm talking to either if it's institutions or individuals that the investor retains full control of their investment decisions. Would you agree with that?

Eric Balchunas:    Yeah. So in my first book, I talk about asset allocation. ETFs make asset allocation so easy. And the idea that the end investor is the decider, whether it's you or your advisor, they're putting ETFs into... Your portfolio's like a pie, and each ETF has a percentage. Those decisions are honestly the most important active decisions you make. So not to say ETFs... So you're making active decisions with largely passive ETFs, but the percentage you pick for your equity, for your international, for your real estate, for your bonds, those are crucial decisions. And that is how, you're right, the end investor gets to control all that. So I think ETFs allow people to of view the world more like an economist now, rather than a bottom up, fundamental stock picker because people have realized it's really hard to know everything.

If you want exposure to say China, what are you going to do? Research every China stock. No, just buy the China ETF makes. It very easy. You can't hit a home run that way because diversification is good for eliminating your downside, but you'll never hit a home run, but you won't strike out. Your diversification is going to save you from anything that could blow up. So a lot of people are willing to make that sacrifice. "Okay fine, I won't pick the perfect stock and beat everybody, but at least I won't lose because I don't want to have my bet on China be right, but I picked the wrong stock," and who has time to research everything and how are you going to know more than people on Wall Street who do this all day every day?

So a lot of people have of thrown their hands up in that and just sort of do active... more like an economist. They view the world and asset classes, and they just put ETFs into sort puzzle pieces in their portfolio, and they shift them from time to time. Even institutions do this. It's almost like those equalizers on a stereo. They go up a little bit, down a little bit, and ETFs make that very easy. And so that to me is how the modern portfolio and investing has really evolved over the years, rather than, yes, outsourcing it to somebody else.

Bill Arnold:    So that of course is talking about the end investor or the institution that is owning the ETFs. Over the last year or two, I've talked to a number of firms that they currently run, whether they're SMAs or CITs, some other investment mutual fund, and I'm curious to hear your thoughts on the conversion from an existing structure to an ETF. How hard is it? Are there challenges with that? Certainly, there's challenges with a lot of things because it's dealing with the ETF ecosystem, but I'd love to hear your thoughts on firms that have done that and what you think is a good means for them to be able to do that.

Eric Balchunas:    Yeah, sure. No, this is some real plumbing type question, and I don't do this every day, so it's like asking me how my sink works a little bit because there is some plumbing that I admit I'm a little ignorant too. But we had, I think it was American Beacon, I hope I don't mess that name up, but we had that guy on our podcast called Trillions, and we interview him for 45 minutes on... He was the first ever conversion. He was sort of Dolly, that the first cloned sheep.

Bill Arnold:    Sure.

Eric Balchunas:    So we were like, "We got to talk to Dolly." So we went through every step of that. Anyway, that might be interesting for people to listen to, to just hear from an actual person who went through it. But he loved it. He was in touch with a lot of his clients. Most of them were happy to do this. It wasn't a big deal. He did have to check a bunch of boxes, but he eventually checked all those boxes, worked all the kinks out, and then just moved it over and felt good doing it. The benefit of converting, in my opinion, is... There's a couple of big benefits. One is you are now where the fish are biting. All the flows go to ETFs. You can't fish in a lake where there's no fish.

Bill Arnold:    That's a good analogy.

Eric Balchunas:    It just doesn't make sense. So after last year in particular, people got more interested in ETFs. Even the biggest holdouts. Like Morgan Stanley's probably the best example. Now, they're going to launch ETFs. They tried DI. They tried to hold out. But after last year, almost a trillion in ETFs. They're like, "All right, we're just going to have to do this." So Morgan Stanley was sort of like the Alamo of the holdouts, and it's finally going to launch ETF. That should tell you a lot. The second thing is you come over with assets, a track record, and most importantly, dignity. If you try to clone your existing strategy and put an ETF out, it's tough. Because unless you're dirt cheap or shiny like the Cathie Wood lane, it's tough to get assets and flows. And you sit there and you don't get any flows for a while, and then you start to get a stank on you like, "Oh my gosh, there's...." because people do want to see some assets in a fund before they buy. It's just the way it is.

And so we found some of the clone ETFs that come out, like the Fidelity Magellan clone is a great example. And that comes in with a huge brand name, so nobody bought it. Now, if it had come into the ETF world like DFA, it basically converted a bunch of big funds into ETFs. It's now the 10th largest issuer. It's all of the sudden a force. It's all of the sudden got this respect-

Bill Arnold:    In the industry.

Eric Balchunas:    Yeah, because you've got all these assets. Assets is marketing. I think you don't want to be... I get the clone thing. You have to have a lot of confidence, but if you come out with this sort of closet indexing, active strategy that's benchmark aware, above 30 basis points, you're going to struggle, and that's where a lot of the mutual fund world is and the SMA world. So I think when you come over to the ETF world, you get to bring all that. Plus, there is a tax benefit too. Because you come over, now you can start using the creation redemption process to limit your capital gains distributions, and so that's another benefit as well. So I would say for all those reasons, we're bullish on conversions, more than any other analyst, I think, ours is the bull more the most bullish.

We think a trillion dollars worth of assets is going to convert by the end of the decade, and we think it's going to involve hundreds of funds. Now, so far, 60 billion has converted, so you can see that's a pretty bold prediction, but we're talking seven, eight years. I think I might have underestimated it.

Bill Arnold:    Do you foresee more of the "active managers," not just the quasi active passive or index hugging, I guess, is what you referring to.

Eric Balchunas:    Yeah, benchmark aware is the sort of [inaudible]

Bill Arnold:    Yeah, benchmark aware. Yeah.

Eric Balchunas:    Like Winnie the Pooh with though monocle on kind of term.

Bill Arnold:    So do you foresee more of the true active managers coming into the space, maybe a little less of the holdings not looking like a benchmark?

Eric Balchunas:    Yeah. So here's what we're seeing. If you convert your mutual fund over, what you do is you take care of the people who are with you now. They're going to have a better fund, a better product, tax efficient, and you have a line in the water where the fish are biting. Will you get bites? We don't know. Now, what I also see them doing is then moving over and maybe trying ETFs that are a little different than their funds. Maybe their 20 best ideas. We do find there's a viable lane. We call it the shiny object lane or the hot sauce lane, and one of the things I go over in the Bogle Effect is the Bogle Effect isn't just, "Oh, all this money's going to passive," it's that the rise of passive is changing everything, and it's changing active. The more passive grows and as the core of the portfolio, the more people are looking for something actually the opposite to decorate it with. That's kind of where Cathie Wood lives and why she's been so durable despite her under performance.

Thematic ETFs have been a big hit here. So what we think is going to happen is active managers will convert their existing mutual funds so at least they can give their investors a better deal and maybe avoid them leaving, so that's a defensive move. Then they go offense by launching maybe high volatile concentrated versions of themselves. So let's say you have a boring 60/40 passive core. Well, you're not going to put on a closet indexing active on top of that because you already own Apple and JP Morgan, all these stocks.

Bill Arnold:    That makes sense.

Eric Balchunas:    So what you want though is something that's different and maybe the 20 best ideas of a manager, so we think that is going to be where active goes. So as we say, the bigger passive gets, the more active active is going to get, which I think they're happier with. I've talked to managers. The idea of holding 300 stocks and adjusting your Amazon between two and 3%, I can't imagine that's a happy existence for you. What's more interesting is these are my 20 best ideas and put that out there. I think this is a good thing for active. I think it'll make active better. So the rise of passive, I think shouldn't be feared, but embraced by active. I do think that's sort of what we're going to see going forward. If you were going to study a company, I would study JP Morgan. They're the ones I think who have gotten it the best in terms of converting what they can, and then setting up an ETF division with an ETF person and letting them sort run wild a little bit. They've been very successful. They're a good blueprint.

Bill Arnold:    That's great information. I guess is a good segue. What types of new products are you seeing coming into the ETF market within the last, call it, year, year and a half?

Eric Balchunas:    It's wild stuff.

Bill Arnold:    I'm sure.

Eric Balchunas:    Single security ETFs, which is an oxymoron.

Bill Arnold:    And leveraged, right?

Eric Balchunas:    How can it be a fund? It's like jumbo shrimp. Single stock ETFs. That's one whole wing that's opening up that we're already seen 40 or 50 of those launch and another 100 filed. Then you've got your typical slew of thematic ETFs, then we've got... Defined outcome ETFs are pretty big. Those are used options to sort of say, "Oh, if the market goes down, you only experience 5%. The next 10% will be covered by the option protection," and so option overlay strategies, I call those package trades or they're kind of like structure products. That's a whole wing opening up because people will pay up for legwork. If you'd go through all that effort to design this outcome for them, they'll pay you for that, and so the ETF rules also allowed a little more derivative usage in ETFs, a little more liberal now.

We also think alternatives are a space that's going to open up because the 60/40's struggling this year, so there's a lane for non-correlated alt strategies. So things that replicate hedge fund returns or a hedge fund type like managed futures or a global macro, long short. Those are ones that I think we'll see more action in. I'm trying to think of what else has launched this year. And then we're seeing the whole culture war. The culture wars have bled into ETFs, so now you've got ETFs that are hardcore ESG, and then a reaction, which is we're going to do everything that's anti-ESG. So ESG sort of brought the culture wars into the ETF, now there's this whole reaction to it. So you've got this right, left kind of political ETF launches going on. That's a whole thing. So yeah, we're pretty busy to say the least.

Bill Arnold:    Absolutely. It sounds very, very interesting. And yeah, every day, you see something new and a new idea. As it relates to the company you work for, Bloomberg, what role does Bloomberg play in the ETF space? What types of datas and functions are available to new and existing ETF providers?

Eric Balchunas:    So Bloomberg didn't do a ton back in the day. I was really pushing it inside. I had seen companies like Index Universe, Morningstar, they were getting more into ETFs. I said, "We got to get involved this more." The good news is Bloomberg has so much going for it in terms of we have all the stocks in the system, we have intra day trading on every security. ETFs, once they get added, they automatically get out of the terminal. So we had the infrastructure set. All we needed was some frosting on the cake, which we did and I helped do that. So now we have ETF specific fields. We have a function called ETF Go, which you can easily sort and look for an ETF, depending on what you're looking for. We have Port, which is like an x-ray machine for the portfolio of an ETF. You can find out where the returns are coming from, compare two ETFs together.

We have BI ETF, which now is time series flows and asset data on all different things. And on our team, we've designed a couple tools called... One of them is called the Smart Beta Spectrum. So you take a bunch of value ETFs, we're going to tell you which ones are most aggressive and least aggressive because there's 109 of them, and they all sound the same, but some are pretty jacked up. They hold only 30 stocks, and they're deep value. Then there's like Vanguard, which is watered down, barely value and everything in between. So we think what's needed for the ETF world is similar to when you go to buy a beer.

Bill Arnold:    Yes.

Eric Balchunas:    There's a percent alcohol. That's important information.

Bill Arnold:    Yes.

Eric Balchunas:    There's O'Douls, and then there's the German hardcore stuff that's like 8%. You need to know this information, and it's going to inform you as an investor. We're trying to do all this for ETFs in the terminal. And so that's generally what we have. But I think our clients tend to pull up SPY or EEM. They look at where it's trading, they look at where they can get the best price on, so our terminal clients probably are looking more in terms of trading and adjusting their portfolios, but we certainly run the gamut on tools we provide for ETF usage.

Bill Arnold:    I always hear it the term, looking under the hood. I think that's what you're getting at with a tool like that to be able to really understand what's in the ETF and be able to make your decisions accordingly.

Eric Balchunas:    Yeah. But there's so many ETFs. There's 180 value ETFs. It's hard to look under the hood at every one, so that's why I think some kind of a quick advanced information beyond the name is important, which we're trying to do. So do you want hardcore value or watered down? Advisors like it watered down. We're not judging, but if value pops and is in vogue, the watered down stuff will lag the more concentrated stuff. So you'd have to know all this, so we want at least get you to the right part of the shelf in the ETF store, so to speak, so that you can then look under the hood with five of them and not 180. We're trying to get you from 180 to five, then you do the look under the hood stuff.

Bill Arnold:    Well, Eric, that it's been great information that you gave us. We really appreciate your time. Thanks so much for sharing your perspective and insights. We really appreciate your time and expertise.

Eric Balchunas:    Great to be here. Thank you.

Bill Arnold:    For those listening, if you have any questions, please direct them to me. My contact details are included on the invitation to this episode. Stay tuned for upcoming episodes in our series. Thanks for tuning in.

Bill Arnold: Good afternoon and welcome to SEI's podcast series, ETF Revolution, a podcast focus on all things ETFs. I'm Bill Arnold, regional ETF director here with SEI.

Joining me today is our featured guest, Brian Gilman, who works for Virtu Financial on the ETF sales and trading desk. Virtu is one of the largest market makers in the ETF industry. With over 15 years of expertise, Brian will provide his perspective on the role and importance of a lead market maker when launching an ETF.

Brian, welcome to SEI's podcast series, and thanks so much for joining me today.

Brian Gilman: Thanks for having me, Bill.

Bill Arnold: So Brian, we've talked to a number of firms that are thinking about launching ETFs or they're contemplating whether it would be a good solution for them. So wanted to hear from your perspective, what role does a lead market maker play as it relates to new ETFs coming to market?

Brian Gilman: Sure. Well, at its core the role of the lead market maker is to provide a two-way market throughout the market session throughout the day, an actionable two-way market. That means is that we're going to have a bid where we're willing to buy that ETF and we're going to have an offer where we're willing to sell that ETF and we're going to maintain that market throughout the session. Now, why that's so important is that for a new ETF or a thinly traded ETF there's unlikely to be a natural two-way flow from market participants there. So without a lead market maker providing that two-way market, you're going to see spreads that are going to be prohibitively wide.

Bill Arnold: So what you mean by a two-way flow is people that are actually buying or selling the product. Is that correct?

Brian Gilman: Correct. So natural buyers and sellers. In early days as the products incubating and growing a lean market maker is really important to maintain a good spread by having actionable markets on both sides before those natural flows come in. And then as a product matures and those natural buyers and sellers do come in, the role of the lead market maker is slightly diminished in that our bid and our offer are not necessarily as important to maintaining the tight spread and the actionable markets.

But where are role then takes us is more around liquidity. We're still there in providing depth to those markets and more volatile markets. When you see some natural buyers or natural sellers begin to step away, that's where Lee market maker is still always there and providing kind of unity and structure to the bides of these products.

Bill Arnold: So certainly that's very important to be in the marketplace, but what type of role do you, as a lead market maker play, when a product's coming to market from an education standpoint? Is that also a very important part of this?

Brian Gilman: Yeah, so I'm glad you asked that question because beyond just providing two-way markets in a name and helping with the market structure and the bid ask spread, we do play a really key role in education. And that role has started much earlier in the process than it used to. I think we're working with prospective issuers, issuers have filed for new products but haven't launched yet, and we're talking to them about basket structure, liquidity profile of their product, best practices for bringing the product to market, best practices for distributing and selling that product. All discussions that we as an expert in ETF ecosystem, someone who's been here and seen a lot of products come to market and have a good idea of what succeeds and what fails, we can impart that wisdom to perspective and current issuers.

And then that education continues even once a product's launched. Once a product is launched, I think we sort of sit in the role of liquidity experts. So we'll work very closely with the capital markets team of an issuer or the sales team, helping to explain true liquidity of a product to their end clients. I think where that's important is as this ETF ecosystem has grown, we've seen both new issuers who come from a mutual fund world and may not be as familiar with the ETF structure or the ETF ecosystem, but also new end clients. So, people who are investing money into the ETF but aren't necessarily familiar with secondary market practices for a product like this, they're used to a mutual fund where they're just going to submit their order and get NAV in the primary market at the end of the day. So we're kind of helping to explain liquidity, helping to explain best trading practices as all these new participants kind of come into our ecosystem.

Bill Arnold: You mentioned new participants, certainly over the last year, year and a half, two years, we've been talking to a number of active managers, so not just the passive managers but active managers. And there was a rule change that occurred a couple years ago, rule 6C11, that allowed for custom baskets. And I'd just love to hear the benefits of that and how that has allowed these new participants to come to the marketplace.

Brian Gilman: Yeah, absolutely. So I think 6C11 and custom baskets were kind of most important for bringing a new level of tax efficiency and an attractive kind of tax efficiency proposition to money managers who otherwise would've just stayed in a mutual fund structure. So, I always talk about ETFs having what I think as two kind of tax benefits. One, a structural tax benefit, which is when investors exit out of that ETF, it's done in the secondary market. Ultimately, it may lead to primary market redemptions, but there are going to be in kind redemptions, you as an ETF shareholder are not going to be affected by the sales of other ETF shareholders as you would in a mutual fund where you might realize a capital gain based on redemption. So that's kind of the structural tax advantage of an ETF.

So then the second tax efficiency of an ETF would be what I would call a tactical tax benefit, and that's where we talk about custom baskets. These custom baskets, which under 6C11, are now available to every issuer, they are just another tool in the ETF toolbox that kind of lets ETFs and ETF portfolio managers be more efficient than they would be in a mutual fund wrapper.

Bill Arnold: From the standpoint of these new entrants that are coming to market, we'd love to hear a little bit more about what types of firms typically are lead market makers in the ETF ecosystem?

Brian Gilman: Sure, yeah. So it spans a variety of types of firms. You have banks involved, you have high frequency shops who are just looking for mostly exchange rebates, you have liquidity providers like Aver too. What I think ties all the various kind of lead market making company types is sort that technological capability to provide a two-way market throughout the trading day and sort of respond dynamically to changing marketing conditions, changing fair values and volatility in the product, and still being able to provide that actionable two-way market in an orderly manner throughout the day.

Bill Arnold: So let's talk a little bit about the experience that end clients will have. What is the importance of keeping spreads small, or can you give us some insight to that side of the equation?

Brian Gilman: Yeah, I think the biggest tangible benefit from keeping spreads tight is that for smaller trades, an end user can route an order to market and receive a quick and fair execution without worrying about how he executes. Just send a market order and be okay. It also certainly helps on the sales side for ETF issuers, if your product has a tighter spread, I think it's an easier sale sometimes to an end user who might not be accustomed to secondary market dynamics. They're not used to even having to think about bid ask they're just saying in a mutual fund, I'm going to place my order and get NAV, and now I'm thinking about where's the bid and where's the offer. So a tighter bid spread certainly kind of helps to sell to that kind of end user.

At the same time, I do think that the kind of focus on the tightness of a bid ask spread can at times be a bit overrated, particularly when it comes to larger block size trades. When you go and you're now trading a larger block size, what's really going to be important is the true liquidity of that basket and the true liquidity of that product. And you might see a block go up inside a bid ask or on the best bid ask, but ultimately I think the importance of the bid ask spread is mostly confined to smaller trades and issuer sales efforts.

Bill Arnold: So how does a lead market maker ensure that there are as tight spreads as needed for the product?

Brian Gilman: Sure. I think when you start to think about that question, it's important to kind of know what goes into the bid ask spread, the market spread that you see on screens. How is a market maker kind of creating their best bid and ask? Well, it's going to start, I think, with the natural intrinsic bide ask of the underlying basket for that ETF. So if you're looking at a basket that holds 25 liquid US large cap names, the intrinsic bid ask spread of that basket is likely pretty tight and you're starting from a tight standpoint. If you're now looking at a biotech ETF that holds 50 wildly volatile and wider spread biotech names, that intrinsic or natural bid ask spread is going to be a bit wider, and that's always going to be the starting point for an ETF's bid ask spread.

Then on top of that, you're going to layer things like what is the liquidity look like of that basket? So the bid and the ask represent the best bid and the best ask of that underlying basket, but now where can you actually go out and source liquidity of that basket? So you might have to add a little more cushion to account for that lesser liquidity of the basket. And also volatility, the more volatile the basket the more kind of bid ask cushion you might see. And then on top of that, you have trading cost and create redeem cost, fixed fees. So things like that will also be factored into how much more spread you need to put on top of that intrinsic or natural spread.

And then lastly, there's inventory costs, which is one that I think a lot of people glaze over, but it's probably the most important cost to a lead market maker. So as a lead market maker, especially in early days, when we're making that actionable two-way market in a product that is not trading that often, we're likely to be the main market participant. So that when someone buys a product, we're likely selling it. When someone sells a product, we're likely buying it. We might get short and create, and we're sitting on long inventory. At the end of the day, as a lead market maker in newer products, we're generally sitting on a good bit of inventory in that product.

Now, the longer it takes to get out of that inventory, the larger financing costs we take on as a firm and we have had to kind of account for that in our bid ask spread. So you may see another layer of bid ask on top of that intrinsic spread for that inventory cost.

Bill Arnold: We've talked from the perspective of the new issuer, ETF issuer come to market or their clients. I'd love to hear your thoughts on what's the benefit of a trading firm like yours to be a lead market maker?

Brian Gilman: I think in terms of tangible benefits, certainly as a lead market maker we do receive some rebates from exchanges, rebate benefits, as well as the opportunity as the best bid and ask throughout the trading session to realize some material gains through spread crossing. To try to capture some piece of that bid ask spread through the trading activity. Now, I would say that at the end of the day lead market making is not a super profitable business. I think that the real benefits to being a lead market maker are the less tangible ones, and that's supporting the ETF ecosystem. So as new products come to market, you really need a lead market maker to incubate that product, to get it off the ground, to let it succeed until it can develop and mature and then continue to provide liquidity support particularly in volatile markets.

So why do we do that? Well, for us as we help these new products and existing products to succeed we're growing the ETF ecosystem and the more the ETF ecosystem grows, all the players in that ecosystem are going to benefit. So, that's certainly a benefit to being a lead market maker. And then lastly, you talked about new players, specifically active managers who have traditionally lived outside the ETF world kind of coming into the ETFs. And a lot of times those are firms that are foreign to us at Virtu. So by being a lead market maker, we get to work with new partners that we might not otherwise interact with, and now we have an open dialogue and we can expand on our relationship and let them see all the capabilities that a firm like Virtu has in terms of market making, analytics, best execution. All the things that Virtu can do. We now have a voice and a relationship to kind of talk about those. So that's certainly another benefit to being a lead market maker.

Bill Arnold: So as these new players are thinking about coming to market, when would you suggest that they reach out to begin the conversation of who their lead market maker should be?

Brian Gilman: Yeah, I think the answer is really it is never too early. Even if it's just at this point an idea for an ETF that you're close to filing, I think that's fine to go out and start getting yourself familiar with the ETF ecosystem. So getting to know who are the lead market makers in this space that you want to talk to, who are the distributors, who are people who can help you bring your product to market like an SEI? All those players in the ETF ecosystem, it's good to be knowledgeable of them and kind of get yourself familiar with them as early as possible. Especially if you're an ETF issuer that's new to this world. If this is your first foray into ETFs, it's really never too early to start learning about the ecosystem and all the parties involved to bring your product to market.

Bill Arnold: I guess as we close up here, is there any last minute closing advice to managers, if you have that what would it be?

Brian Gilman: Yeah, I think just going back to the last question, get to know the ETF ecosystem as early as possible. Work and get feedback on your potential product so that when you get ready to bring it to market, it's fine tuned for liquidity and for best. And then on top of that, have a real defined plan for your launch. That means what is the product going to look like? What are the unit sizes, the NAVs the creation redemption mechanics, Everything should be nailed down way ahead of launch. But then on top of that, distribution. There's nothing more important to the success of a product than having a distribution plan. I mean, there's 3000 plus products in market. You're not just going to launch an ETF in this day and age and have it succeed on its own. You need to have a really strong distribution plan.

Bill Arnold: Certainly, and a lot of the conversations that I've been having that seems to be the number one component of it. It's all, it's talking about the distribution strategy that you have in coming to market. For sure.

Brian Gilman: Totally.

Bill Arnold: Well, Brian, thanks so much for sharing your perspective and insights. We really appreciate your time and expertise. For those listening, if you have any questions, please direct them to me. My contact details are included on the invitation to this episode. Stay tuned for upcoming episodes in our series. Thanks for tuning in.

Brian Gilman: Thanks Bill.

Bryan Paone: Welcome to ETF Revolution, a podcast where we focus on all things ETFs. I'm Bryan Paone, Relationship Manager and ETF Specialist with SEI. Joining me today is our guest, Ali Doyle. Ali leads Business Development for NASDAQ's ETF Listings Business. Ali, thanks so much for participating in our program.

Alison Doyle: Yeah. Thanks, Bryan for having me.

Bryan Paone: Of course. Over the next few minutes we'll discuss the role exchanges play in ETF listing and trading. We'll also get into the ins and outs of working with an exchange to launch and list an ETF. Let's start by talking about any interesting trends you're seeing this year with ETF product launches.

Alison Doyle: Yeah. Launches have certainly not slowed down this year despite the pullback that we've seen with the IPO market. Right now, we're relatively on par with where we were with launches in 2021. As of June 30th 2022, there have been 164 net new launches. Taking into account any D listings. For the same time period in 2021, there were 166 net new launches. Then thinking about some of those recent trends, the single security levered in inverse ETFs have certainly gotten some recent coverage. These are the first of their kind to be launched in the US. They've already existed in Europe.

Bryan Paone: Yeah. I mean, thinking about some of this thematically, I think it's an extension of the trend we've been seeing over the last few years since the ETF Rule or 6c-11. Really, this regulation lowered the barriers for managers to enter the ETF space, and I think you saw some interesting strategies launch not long thereafter. Options overlay for one, defined outcome and now to your point, single stock.

Alison Doyle: Yeah. No, definitely, and then a couple other points. We continue to see mutual fund to ETF conversions, but also SMA to ETF conversions, so that's been interesting, and these tend to be actively managed strategies. Thinking about active in general, there haven't been as many semi-transparent ETF launches this year. They've mostly been either passive or active transparent.

Bryan Paone: Yeah, look, I also think that's a trend that's become a lot more popular since 6c-11 also. I remember looking back at the beginning of this year for the stats on 2021, and it was like 307 of 470 ETF launches during 2021 were active ETFs. Maybe I shouldn't be, but I was a little bit surprised by that. To put that in context, as we sit here in August of 2022, there's 912 active ETFs. Looking back on the 307 that launched in 2021, roughly a third of them, of the 912 launched last year.

Alison Doyle: Wow.

Bryan Paone: That's a long way from where we were a decade ago. I mean, think back, there was only a handful of active ETFs and the firms that had them really struggled with distribution.

Alison Doyle: Yeah, yeah, and then to that point, who is launching all of these new products? It's definitely been a mix of established ETF firms you're already familiar with, a lot of new boutique issuers and also firms which have traditionally played in the mutual fund space that are just getting into ETFs for the first time.

Bryan Paone: I think that also piggybacks your mutual fund to ETF conversion, which we've seen a lot more of. I think also thinking about some of the firms that the more boutique and newer types of managers who are launching ETFs, there are probably folks who, or in a lot of cases there are folks who resisted ETFs for a long time. But now with the rise of the semi-transparent active, it gives them a new avenue to explore ETFs.

I think a lot of the interest that we're seeing in semi-transparent structures, we're having a lot of conversations around them. In many cases, the folks that want to initiate that conversation end up launching in the fully transparent active space. Look, that's definitely not meant to be a knock on the semi-transparent structures. I think they have a lot of merit. I think managers of many types should consider them.

But I'm just kind of from my background and from my experience, some of the things I've seen, a lot of those conversations tend to go the fully transparent route. But it's like ETFs 20 or 30 years ago, fixed income ETFs a decade ago, these semi-transparent structures are going to benefit from the providers that have them going out and talking about them and educating the community. I think it's just a slow build, an educational build, but I'm sure in time we'll be seeing more of those launch as well.

Alison Doyle: Yeah, and obviously right now, those semi-transparent wrappers are only approved for domestic equity strategies. Time will tell and we'll continue to see how that space evolves?

Bryan Paone: Yeah, another great point. Let's switch gears for a minute. Most of the people listening to this probably have a good idea what the exchanges do, at least when it comes to individual stocks. But what role do the exchanges play in exchange traded funds?

Alison Doyle: Yeah. I can really only speak with the way NASDAQ approaches ETF issuer relationships, but we really look to be an extension of the full issuers team and we provide support in a variety of areas. This includes legal and regulatory guidance, co-marketing tactics, and ensuring there are fair and orderly markets for ETFs through our DLP programs.

Starting at the beginning, when an ETF issuer is looking to launch a new ETF, they will first file with the SEC. As you mentioned, Bryan, with the ETF rule from 2019, certainly lower barriers to entry for issuers to bring new products to market. Lots of new issuers for us at NASDAQ to be working with. Particularly for those new issuers, our ETF listings team will play a consultative role and provide insight into the ETF industry that would be relevant for those respective strategies. We can also provide content that can help those issuers educate their internal teams that really might not be as familiar with the ETF industry.

We tend to hear questions such as, "Which market makers are best suited for my product? Should I create my own trust or leverage a third party? And how can my firm leverage the NASDAQ brand to help market my product?" Issuers also reserve the ticker they would like to use through their listing exchange, so we're able to support them with that as well. But so Bryan, to actually throw one of those questions back to you, how issuers are choosing to either build out their own trust or leverage a third party such as SEI, how do you and your team think about that?

Bryan Paone: Yeah, that's a great question. To be clear for the folks listening, the two options are to either form your own trust where the manager would need to put their own board in place, hire a chief compliance officer and a legal counsel, and would also need to develop relationships with all the service providers separately. That includes your fund admin in accounting, custody, transfer agent, distributor, the list goes on and on.

Or, the second option is to go out to a third party trust, or an outsource series trust, that already has all these providers in place. But to answer the question, it depends on the overall strategy for that particular firm's ETF business. In the series trust option, if a manager sees itself launching only a handful of funds, let's say less than 10 or so, then the third party trust becomes very appealing. There's a lot of scale to be had from joining a third party trust that already has all these providers in place and allows the manager to benefit from that scale and sharing costs with the other managers and funds on the trust.

As far as the build your own trust option goes, that may make sense for a lot of managers as well. One of the primary regulatory requirements is that a board is primarily independent, but one of the benefits of building your own trust is that it allows you to have a more direct relationship with the board and be involved in recruiting those initial board members.

But there's some downsides as well. There's a lot of cost associated with building and hiring your own board. Then there's also the ongoing activities associated with managing and maintaining those relationships with the service providers. There's also the time spent preparing for and reporting to the board, and all those things can really stretch resources. It's one of the many reasons why a lot of managers choose the outsource series trust model. At the end of the day though, it's really a business decision that each particular manager needs to make.

Alison Doyle: Yeah. Those are good points.

Bryan Paone: One thing I actually want to go back to is your initial response. You had mentioned your DLP program, so can you tell us a little bit about what that is and what impact that has on managers?

Alison Doyle: Yeah. To take a step back for anyone who's not familiar, a market maker is a broker dealer that regularly provides two-sided quotes to clients. When a new ETF comes to market, an issuer will select a primary market maker who is incentivized to meet certain market quality metrics and receive incentives tied to those efforts. Other exchanges refer to these firms as lead market makers. NASDAQ classifies them as designated liquidity providers or Bryan, as you said, DLPs, so those are really interchangeable terms.

NASDAQ currently has four requirements as part of our program, and we are adding a fifth auction quality requirement in a few weeks, and that's really a direct result of issuer feedback we received. There are 14 firms that currently act as DLPs, and we're always happy to make introductions for issuers looking to get connected with these firms. Then along with choosing a lead, an issuer is able to bring on a secondary DLP to help support market quality, and we've seen that mostly happen for newer products or illiquid products.

Bryan Paone: How many of the funds, or I guess I should say how many of the managers you work with, tend to utilize the secondary DLP program?

Alison Doyle: It's definitely grown over the past couple of years. We've had the secondary program in place for a while, but we formalized it in mid 2021. We've definitely seen a lot of growth. As I said, it's mostly for those newer products or a lot of existing established managers have leveraged it again for products that are still more thinly traded looking to take on some additional DLP support.

I think it's also great, it's a great opportunity for those DLPs that may not have relationships with certain new firms, and it's not as large of a responsibility as being a primary DLP. But again, they are receiving certain incentives tied to those market quality efforts.

Bryan Paone: That makes sense. Thanks for the insight. For anybody new to ETFs, they may hear about how ETFs have two different markets, a primary market and the secondary market. Help us understand this a bit and how each of those apply to the exchanges?
 

Alison Doyle: Yeah, so the key difference between these two markets is really thinking about from where the liquidity is being derived? Starting with the primary market, the liquidity there is really a function of the value of the underlying shares that back the ETF. Firms called authorized participants, which are self clearing broker dealers, can either create new or redeem existing shares of the ETF. Exchanges really are not involved with the primary market activity because this is taking place between those authorized participants and the ETF issuer directly.

But when thinking about the secondary market where liquidity is more a function of the value of the ETF shares traded on exchange, again, that's really where the exchange really comes into play. Market makers are much more involved here as they are key liquidity providers in that ETF ecosystem, ensuring continuous and efficient ETF trading in the secondary market.

I know this is one key component to ETF education that issuers really look to stress, not only with potential investors, but also with their internal stakeholder teams. Just ensuring that there's a strong understanding of both of these layers of liquidity in the primary and the secondary market, because that's important to understand, to know the best way to trade these products.

Bryan Paone: Yeah, look, I think it's one of the important and key concepts when it comes to thinking about and evaluating ETFs, especially for end investors when you think about, to your point, trading, executing in these products. So, let's think about the launch process for a second. At what point in that process do ETF managers, or I guess at this point prospective managers, typically engage with you guys?

Alison Doyle: Yeah. Issuers tend to meet with all three of the ETF listing exchanges to best understand our offerings before making their final selection. We tend to speak with issuers roughly two to three months prior to their targeted launch date, but we've also developed relationships with issuers far sooner in their process and can help support product development ideas. Particularly if those issuers are leveraging a NASDAQ index or if they think their ETF is not going to fall within the ETF rule parameters, we're able to discuss with them the best way to approach, particularly from a legal standpoint. Bryan, what have you found? When do ETF issuers tend to start working with the SEI team?

Bryan Paone: Yeah, I think for us, it really depends on whether the manager or that firm is a client already. If we have an existing client that utilizes us for some other product wrapper, mutual fund or whatever else, or already has ETFs with SEI that we service, then I think we're engaged really early in the process. It's something they'll come to and start socializing an idea with us.

Or in the earlier example, if it's someone that runs a separate wrapper and is thinking about getting into ETFs, there's a lot of education many times that goes on up front. That lead time can be very long. Sometimes not, but usually we're engaged at the very early stages. For managers who aren't a client of ours or who may be a new manager, sometimes we're involved a little bit later in the process, and I would say that mainly has to do with the plans that they have.

Typically, that plan is a little bit further along in the process by this point. They've decided that they are going to go down this path. They have an idea for a product in mind, so tend to be engaged a little bit later in the process for non-existing clients or for newer managers. But either way, I think in either one of these scenarios, my advice to any prospective manager would be to engage with as many players, whether it be exchanges, as many of those or service providers of any sort, as many of them as possible as early in the process to really get the education up and to socialize the ideas and make sure everybody's on the same page.

Alison Doyle: Yeah, definitely.

Bryan Paone: I think one of the things that I think about from the development of the industry over the years is really how crowded the ETF industry's gotten. Maybe crowded is not the right word.

Alison Doyle: I think some would say it's getting crowded.

Bryan Paone: It's true. I mean, look, I think from an investor standpoint, you wouldn't. There's no shortage of choice. It's a great thing for investors, any strategy that they want. For example, they can buy an ETF format, and I think that's a great thing. But from a manager's perspective, how do they compete for airtime?

Alison Doyle: Yeah. Well, to start off, you're definitely right with over 2,900 US listed ETFs at this point, issuers definitely need to take the time to think about their distribution and marketing strategies for their products. In terms of how they can best leverage NASDAQ's co-marketing strategies to help with that effort, it depends which area of the market they're looking to access, such as retail investors, high net worth individuals or financial advisors.

I can touch on a couple of the popular marketing tactics that we're able to bring to issuers. Issuers can be featured on our interview segment called TradeTalks, and that's with our global markets reporter, Jill Malandrino. These are great three to five minute segments for the issuer to give both a broad market update, as well as talk a little bit about one of their products.

We're also able to display tower shots on NASDAQ's Tower in Times Square. For anyone who's walked through Times Square, it's pretty hard to miss and we're able to put up these tower shots both on launch day to commemorate a new product, but also if they hit an AUM milestone or a notable anniversary. Then both through our organic social media channels, viewership on nasdaq.com, along with paid social media campaigns that we're able to work on with issuers, there is definitely a lot of support that we can provide, especially those new issuers that are looking to get their brands seen by potential investors. This is really just skimming the surface, I'll say. I mean, we love working closely with issuers both before and after their launch on how to execute an effective marketing strategy.

Bryan Paone: That's actually interesting. It leads me to another question, which actually may tie back to the previous points we were making. What does the ongoing dialogue look like for you, and who do you tend to work with at some of these issuers? What roles do you tend to engage with?

Alison Doyle: Yeah, once the product is launched from the ETF listings business side, we work closest with capital markets teams and sometimes product development teams. Then our marketers at NASDAQ tend to have parallel dialogue going on with the marketing teams at those issuers to really get into the weeds on some of the marketing tactics that we can offer.

A lot of the times we will schedule recurring calls, whether it's monthly or quarterly, to maintain those strong ties of communication, and it gives us a chance to discuss relevant regulatory updates that might be coming up, potential changes to our liquidity programs, and of course be kept up to date on what's next in the issuer's pipeline?

Bryan Paone: Which is important, and certainly as many of these issuers look to probably launch more than one ETF, right? It's important to understand what's coming next to be able to align those resources.

Alison Doyle: Yeah, I mean, really overall, our main objective at NASDAQ is to build these strong holistic relationships with issuers and not just think about one product, but really how we can help the issuers grow their brand and product lineup hopefully into the future?

Bryan Paone: Which makes a lot of sense. I mean, you think about the three silos of ETFs from somebody who's going to bring them to market. You really need to nail down the plan in three areas. The first is distribution, which I think is a lot of the marketing that we're talking about. The second is product strategy. Again, some of the things we've touched on here, what is the line going to look like in the third product, fifth product, tenth product? What are the end goals?

Then what partners do you work with? What exchanges do you work with? What market making partners? I think the insight that you guys provide is invaluable to managers. Let's close with any tips or last minute advice you might give to managers thinking about launching an ETF?

Alison Doyle: Yeah, I think we hit on it, but I would definitely say marketing and distribution strategy is key. Before being at NASDAQ, that was my background in ETF distribution, and I think that's just definitely one component of a firm strategy that needs to be considered, whether it's wholesalers leveraging a third party distribution platform or something along those lines, just to make sure that you're getting your products out there in the right fashion.

Bryan Paone: Excellent. Appreciate the details there. Ali, thanks so much for sharing your perspective and insight. We really appreciate your time and expertise. For those listening, if you have any questions, please direct them to either Ali or I. Our contact details are included on the invitation to this episode. Stay tuned for upcoming episodes in our series, and thank you for tuning in.