Over the years, countless independent research firms have asked the team here at Integrity Research how to grow their revenue. However, as conditions in the institutional research business have become more challenging, IRPs have started asking how best to diversify their revenue. One approach a growing number of research firms have started to investigate has been how to turn their research into investable products, including UITs and ETFs.
Can I really make money in ETFs & UITs?
This is typically the first question IRPs ask us when considering entering the ETF business. The short answer is yes, but there are a number of qualifications to this answer. First, you need to develop a successful and saleable strategy based on your research. Second, you need to find the right partners who can launch and market your product (and negotiate the right commercial deal with those partners). Third, your strategy and partner needs to gather sufficient assets to make it worthwhile for everyone involved.
While a number of research firms have tried to get into the UIT and ETF business over the years, a few have achieved considerable success. Of course, most of us have heard about the sale of independent research firm Dorsey, Wright & Associates to NASDAQ early this year for $225 million. The primary reason the firm received such a healthy price tag was due to the array of 17 ETFs, UITs and other investable products with close to $6 billion in AUM the firm developed and launched over the years.
However, other IRPs have also had success in the space including GaveKal, TrimTabs, Sabrient, and Argus Research. In fact, a few of these firms have been able to generate millions of dollars in fees annually from these endeavors – enough to make selling their research to institutional investors a secondary revenue stream. For example, over the past five years Santa Barbara California-based quantitative research firm Sabrient Systems has built and launched a series of UIT and ETF products with close to $10 bln in AUM.
Do You Have To Be Registered?
The second question we get from IRPs is whether they need to be a registered entity to get into the ETF business. The answer is, it depends. In fact, firms like Dorsey Wright, GaveKal, TrimTabs and Argus Research have all established registered investment advisors to house their ETF and UIT businesses. However this is not necessary.
Most IRPs first get started launching investable products by developing portfolios or unique indices based on their research process (like Sabrient’s Baker’s Dozen portfolio or their Insider Sentiment Index) which generate strong historical performance over time. These indices or portfolios can be licensed to UIT or ETF sponsors for the purpose of building investable products based on this research. The IRPs generally earn licensing fees for their research based on the assets under management gathered in the UIT or ETF.
It is important to note that research firms that have RIA subsidiaries are generally able to earn higher fees for the research they provide as they act as subadvisors to the funds rather than just index providers.
Which Product Should I choose?
Most IRPs we speak with have heard of exchange traded funds or ETFs. However, fewer have heard of unit investment trusts (UITs).
A UIT is an exchange-traded fund offering investors access to a fixed (unmanaged) portfolio of securities which has a defined term or life (often 1 year). Unlike open-end and closed-end investment companies, a UIT has no board of directors. A UIT is registered with the SEC under the Investment Company Act of 1940 and is classified as an investment company. UITs are assembled by a sponsor and sold through brokerage firms to investors.
The benefit of a UIT to an IRP that is considering launching investable products is that the fees charged investors for these products is considerably higher than for an ETF. This means the index provider can earn higher fees for a UIT than for an ETF. The second reason some IRPs like UITs is these products often take less time to launch and they normally have the marketing efforts of a firm’s brokerage staff behind them.
However, some IRPs don’t like the fact that UITs are fixed portfolios of a small number of stocks (e.g. 30 stocks) that remain unchanged for a specific term. Consequently, a more dynamic instrument like an ETF where a larger number of stocks (for example, 100 stocks) can be changed on a daily, weekly, or monthly basis makes more sense given some firm’s research process.
Ultimately, an IRP doesn’t have to choose to launch only ETFs or UITs. Rather, they can choose to launch both if their research process allows them to produce appropriate portfolios or indices that perform well over time.
How Much Does It Cost?
Of course, many IRPs have been scared off from trying to create and launch ETFs and UITs due to fears of how much this might cost them. However, the cost of developing and launching these products depends on the direction a firm wants to take.
Firms that want to launch these products themselves could spend anywhere between $250,000 to $300,000. This includes the cost of hiring ETF-in-a-box solutions provider who handles the product registration, recordkeeping and other administrative aspects of operating an ETF. Additionally, an IRP would need to find and negotiate a deal with a marketing firm who could raise assets for the fund.
Of course, an approach that requires a much smaller out of pocket investment is to contract with an ETF or UIT sponsor to provide the registration, recordkeeping, and marketing of the product. The only downside of this approach is that the IRP earns significantly less by being purely the index provider or subadvisor. The primary costs associated with this approach (less than $15,000) would be the costs of developing an index or portfolio, the marketing costs associated with finding an interested sponsor, and legal costs to negotiate a final contract with the ETF or UIT sponsor.
It does not make sense for all independent research providers to consider creating ETFs or UITs. It really depends on the uniqueness of your firm’s research process, your ability to create strategies which can be turned into portfolios or indices, the performance of these strategies, and your patience (it normally takes at least 2 – 3 years for an IRP to start seeing significant revenue from this endeavor).
However, research firms that have the various pieces mentioned above, and who are willing to commit to this effort for a few years, could be in a position to be handsomely rewarded. Any research firms who are interested in having a discussion about the possibility of developing a new revenue stream for your business, contact Mike Mayhew @ Michael.Mayhew@integrity-research.com