So, you’re thinking of launching ETF share classes? Then, you will have seen recent news about the Irish regulator’s approval for the launch of four of them in Ireland, where the majority of European ETFs are based.
While the news comes five years after the Central Bank of Ireland first gave asset managers greater opportunity to launch ETF share classes, it indicates that these structures finally may be gaining traction. Asia was out of the starting gate sooner - Hong Kong’s CICC was among the first banks to launch unlisted share classes, appointing BBH as fund servicer, in 2019. In the U.S., Perpetual is seeking approval to add an ETF share class to seven existing mutual funds.1
Regulatory policy in Europe and the U.S. means more managers are considering launching listed and unlisted share classes within the same sub-fund. For funds that launch both, all share classes are part of the same legal structure, have the same investment manager, and the same underlying assets and valuation policy.
Benefits of launching sub-funds with both listed and unlisted share classes
- They provide investors with both listed and unlisted options to access the same investment strategy
- They can open doors to both legacy and emerging distribution channels with private banks, retail platforms, and institutional investors who may see growing interest in listed share classes
- The costs to launch a new share class are much lower than launching a new sub-fund. Also, the time to market for a share class is quicker than for a sub-fund
- They allow investors to leverage performance history of the existing share classes
However, there are key structural differences:
- Listed share classes trade on-exchange and are purchased from a broker at a price determined by a market maker, whereas unlisted share classes are purchased directly from the fund at NAV
- Most listed share classes are required to publish their holdings daily and, depending on the exchange where they are listed, publish an indicative NAV throughout the day.
What should managers intending to launch these structures consider?
Cannibalization threat real/not real? While the share class structure is in its infancy, there are examples of asset managers who have the same strategy in mutual funds and ETFs. This has not led to significant outflows from mutual funds into their ETF equivalent products.
Launching an ETF share class can be considered a defensive play for managers who are seeing outflows from their mutual funds into ETFs. Also, it provides an additional distribution channel for the same strategy.
However, in an instance where a manager is looking to launch an ETF class within a mutual fund, the CBI would require UCITS ETFs to be included in the name of the sub-fund. This may be a hinderance for those managers with mutual fund investors and should be carefully managed.
Get ‘ETF ready’. Managers should expand their infrastructure and operating model to support ETFs. This includes the disclosure of the portfolio holdings as required under the fund’s regulatory regime, implementation and oversight of ETF specific workflows, and assigning or hiring capital markets personnel.
Leverage existing distribution network. The sale of mutual funds and ETFs require different levels of expertise and compensation structures. To achieve economies of scale, managers should consider how to leverage their existing distribution network to sell both listed and unlisted share classes.
Tax implications. ETFs may have access to double taxation treaties which can impact positively on performance. Managers should consider the potential impact on accessing these treaties with the launch of listed and unlisted share classes within the same umbrella.
Shareholder treatment. Issuers should limit the impact of order activity on one group of shareholders versus another. For example, swing pricing is typically applied in mutual funds/unlisted share classes for this purpose. For ETFs, the actual cost of trading the basket (or NAV plus a variable fee) is applied to each creation and redemption order and paid by the fund’s Authorized Participants (APs). Managers who launch listed and unlisted share classes may decide to apply swing pricing to the unlisted share class only and NAV+ or actual costs to the listed share class.
Consider your service partner’s support capabilities. Supporting NAV production, transfer agency, and custody of share classes in the same structure, are table stakes. Other areas to consider include:
- Are fund accounting and transfer agency systems set up to handle the unique operational nuances of supporting listed and unlisted share classes?
- If required, can the fund accounting agent provide swing pricing on the unlisted share class?
- Does the investment manager require amalgamated reporting to manage both classes and if so, can the service provider deliver?
Beyond the news headlines, careful consideration of listed and unlisted structures by managers could ensure they reap the rewards of the innovation, which has many potential benefits for issuers and investors. Ultimately this will provide more product choices, access to new distribution channels, and minimize the cost to managers/investors.