Frank Koubelka

SVP & Global ETF Product Specialist, State Street Global Services

Summer may be over, but the active ETF market continues to heat up. In this week's issue, we sit down with one of the key service providers in the ETF industry, State Street Global Services, to discuss the common questions from new ETF issuers and how Frank Koudelka views the future growth prospects for active ETFs.

State Street Global Services is a leader in ETF services and custody for the ETF market and NYSE clients. What are the key questions new entrants and clients are asking today?

The two key questions we hear from new entrants are:

1. Is it too late to enter the ETF marketplace?
2. What changes (for both technology and resources) will I need to make to be successful?

Our answer to the first question has been: it is not too late! The key for success is to stay close to the DNA that has made you successful within other investment wrappers. In other words, launch your top strategies. Taking a failing mutual fund product and slapping the ETF investment wrapper on it is not the recipe for success. There also needs to be support from across the organization, including investments, product, sales and marketing, etc.

Regarding changes that need to be made, there are nuances to the exchange traded funds that are different than that of a mutual fund. The first is the basket process, which doesn’t exist for mutual funds. The investments team is responsible for the formulation of constituents and shares that make up the trading basket or the portfolio composition file. For the semi-transparent active models this will be a pro rata representation of the fund or a proxy basket. If it is a pro rata representation, service providers can create the basket by sourcing the accounting book of records and market trades executed by the investments team. For the proxies, most have desktop tools that can pull in the fund holdings to create the proxy constituents. From a resource standpoint, State Street always advocates hiring an experienced capital markets resource to face-off with exchanges, authorized participants, market makers, IOPV agents, etc. This would be a minimum requirement. Depending on how big the firm’s ETF push would be, other key hires would be a Head of ETFs, ETF Sales Specialists and ETF Product resources.

When firms are looking to enter the ETF market, particularly as an active manager, what are some of the overlooked questions that your team addresses?  

State Street has resources that sit outside of our ETF servicing and operations teams that are dedicated to education, understanding the ETF ecosystem, onboarding / launch support and industry best practice. We have had many educational sessions with active managers before they have considered a formal entry to the ETF marketplace. These generally focus on the nuances of the various models, what they can expect to change internally if they launch an ETF and who are the other players in the industry they should be talking to.

When a launch process kicks off in earnest, we typically focus first on the basket process with the investment team. Getting them comfortable with the process, including a model office test plan, is paramount to success. We break up the launch into logical pieces (workstreams) and assign a workstream lead to each. We bring the entire team together for weekly check-ins. This has been effective in getting everyone on the client side the information they need to launch and then to bring it all together to a centralized project manager and project plan.

State Street works with clients across ActiveShares, NYSE, Fidelity and T. Rowe proxy ETFs. What have your early observations been on the servicing and operational impacts of these new structures? What hurdles do you see on the horizon for these semi-transparent structures?

State Street took the long view on these structures. We've been deeply involved with the intellectual property creators, clients, exchanges, market participants and regulators for 10 years. Although the models changed from the initial filings, we had sketched out what would need to change from a servicing and technology standpoint. They are structured as traditional ETFs, so the "extra" work is done in the back office and doesn't impact the end investors or advisors. State Street developed new services (the authorized participants representative, or APR, in the Precidian ActiveShares structure), expanded existing capabilities (performance reporting comparing the proxy portfolio to the fund) and enhanced existing tools (separate transparent and non-transparent baskets to APR and AP, respectively).

As far as hurdles, I do not anticipate any related to ETF servicing capabilities. We've been asked several times by clients to opine on "winners" and "losers" from a structure / model standpoint. I think it's too early for that and don't think it matters. The different models might work more effectively depending on asset class, geography, concentration, etc. Clients should think about the strategy they want to launch and talk to market makers about which would make the most sense for that particular ETF. Look, American Century Investments has launched with both the ActiveShares and NYSE models. GSAM has filed for the ActiveShares and Fidelity models. Invesco has filed with the Fidelity and its proprietary models. Asset managers should launch what makes the most sense for a fund to be successful.

The active ETF market now offers asset managers a lot of choice when considering product design. How has State Street navigated and prepared for the various structures that are in market? What should new entrants consider as they assess entry?

Since we began this journey 10 years ago, culminating with the launch of the first semi-transparent active ETF on March 31, 2020, our goal has always been the development of a scalable service model and technology. This means that all the work the pioneers have completed to get to launch is available across our platform. We have been able to leverage what was developed for each of the subsequent launches. Obviously, the ActiveShares and Proxy Basket structures are different. But if you look across the Fidelity, NYSE, T. Rowe Price and Blue Tractor models, there are a lot of similarities from an ETF servicing standpoint. The biggest lift was the development of a suite of reports (tracking error, standard deviation, empirical percentiles, overlap) developed by our Performance & Analytics team that compared the performance of the proxy basket to the ETF.

New entrants need to consider the asset classes in scope (very limited currently, but we hope it expands), the models that make the most sense to their proposed strategies and how they can get educated on the changes that will impact their organization.

As a servicing and custody firm, what guidance would you provide sponsors as they consider expanding their product offerings to include actively managed ETFs (either fully transparent or semi-transparent)?

First and foremost, ETFs have some structural differences when compared to mutual funds. Most of the new entrants we speak to in the marketplace come from a mutual funds background. Get educated on the new ecosystem that will drive the success of your ETF. Read newsletters like this one. Attend conferences or webinars. Meet with (virtually these days…) exchanges, market makers, authorized participants and service providers. We are all available to provide education sessions. It is for the good of the industry and we all try to do our part. I typically spend half of my time visiting clients and educating them on the ETF market. Now I'm doing it virtually. It is time well spent by asset managers that have an active launch strategy or are curious about the market.