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April 1, 2014

Anatomy of an ETF Challenger

By Renee Caruthers

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For Source, the concept of multiple partnerships is part of its genesis, based on opportunities it saw in the way the European ETF market was unfolding when the company was first founded. Prior to Source's launch in 2009, there were ETF products in Europe offered by asset managers and by investment banks. The investment banks had interesting products, but they were vertically integrated products with a lot of single-counterparty risk. As Source's founders hailed from investment banks (Lytle and CEO Ted Hood are from Morgan Stanley, and chief strategy officer Peter Thompson comes from Goldman Sachs), they decided upon a hybrid model: an asset manager backed by multiple investment banks with equity stakes. "We decided there is an opportunity to create a hybrid model, which is an independent asset manager, but one that is completely up to speed on what is going on in the sales and trading market and that can take advantage of all these elements of value that the investment banks are trying to take to the table," Lytle said. "But we wanted to do it in an independent, multi-counterparty way to avoid undue exposure to any one entity."

 

ACTIVELY MANAGED ETFS

Source's policy of strategic partnerships has brought it into what was initially relatively uncharted ETF territory. Where ETFs originally tracked benchmarks, several of the ETFs that Source introduced veered from benchmarks to incorporate investment decisions, becoming what are known as actively managed ETFs.

"When we launched our first active ETFs, people were a little surprised, and they thought, 'Do active and ETF really go together?'" Lytle told Traders. "Now people completely accept that active can be wrapped as an ETF. It just becomes the challenges for the manager of the product as to whether they are willing to give the level of transparency around the strategy." He added that some fund managers might have concerns about the potential overlap of distribution between traditional fund sales and their ETF sales.

With Pimco, Source has four actively managed ETFs, two of which are $1 billion or more. Three ETFs that Source distributes for Man Group are essentially actively managed as well, though algorithms, rather than humans, are selecting the stocks.

"We've got pretty good evidence that active and ETF can work together, but we are one of the few that have raised any meaningful assets in active ETFs, so we think there is a little bit of special insight needed to make it work," Lytle said.

 

EUROPE RISING

While Source has big ambitions, plans are to continue to focus its efforts on the European ETF market. "We think there is significant opportunity in Europe for a number of reasons," Lytle said, noting that the European ETF market started in 2000, seven years after the ETF market began in the U.S.

"If you plot Europe growth versus U.S. growth basing to year zero, Europe is doing very well and growing faster than the U.S. did. But in the last seven years, the U.S. has gone through a hockey-stick growth where it has really taken off exponentially. We hope that happens in Europe and we want to help the industry do that," he said.