Exchange-traded funds (ETFs) have been around only since the 1990s, and their explosive popularity and the sheer range of them available have made some investors wonder whether they couldn't just create and manage their own exchange-traded fund. One of the benefits of the ETF, after all, is its straightforward nature. There's no stockpicker pulling levers behind a curtain. Most funds mirror an index, sticking as closely as possible to the content and the weighting of the index in order to match its returns.
It's difficult but not impossible to launch an ETF. It takes seed money, and it takes skills and knowledge in finance, marketing, and financial regulation. You can even hire a company to help you create, launch and manage your ETF. Here's what you need to know to launch your own ETF.
- Starting an exchange-traded fund requires significant startup capital and financial expertise.
- You can hire a firm to help create, market, and manage your fund.
- The startup costs include about $2.5 million to purchase shares of the assets in the fund in order to launch it.
- You can start small by creating a person ETF for yourself, even using fractional shares to seed the fund.
- Beginning investors may choose to invest in existing ETFs instead.
The first ETF was the SPDR S&P 500 ETF, which remains an actively traded ETF today.
Understanding an ETF
An exchange-traded fund is an investment in a selection of stocks or other assets. Most track a particular index, like the S&P 500, but they also may be based upon a particular sector or commodity.
One of the key features of ETFs is their ability to offer diversification, allowing investors to gain exposure to a broad range of assets within a single investment. Instead of having to buy 30 different stocks, for example, you could just buy one share of an ETF that has ownership in those 30 different stocks.
An added benefit is that ETFs trade on an exchange like a stock. This means their prices can fluctuate throughout the trading day based on supply and demand. However, this also means it's easy to buy and sell shares of any ETF as long as it's on a public exchange and there's enough liquidity.
Creating an ETF
An investor who wants to create an ETF must have some strong views on what the makeup of a successful ETF should be. If they expect to market the ETF to other investors, they must be able to communicate those views effectively.
The majority of ETFs are passively managed, tracking a set of stocks, vs. actively managed, like a mutual fund, in which a person or team decides which stocks to add and remove from the fund. Yet, even those ETFs that are not actively managed still require significant time and attention from a manager to ensure that the fund components continue to match the selection and weightings in the index that it tracks.
If you have cash in the six-figure range or more, and you're determined to start your own ETF, here are some considerations for designing your own ETF:
- Asset class: Will your ETF invest in stocks, bonds, or other types of assets? You can diversify the fund across asset classes, although that is not common.
- Market capitalization: What size companies will the ETF invest in? You can focus on large-, medium-, or small-cap companies, or diversify across market capitalization sizes. Focusing on large-cap stocks generally requires the most seed capital.
- Market sector: Will your ETF focus on a specific industry or invest across sectors? Consider focusing your fund on a market segment in which you have a strong interest and knowledge.
- Fees: What annual fee, known as the expense ratio, will you charge? Most investors understandably pay close attention to the fees they pay for their investments, and ETFs are known for their very low expense ratios compared to mutual funds and other investments.
An ETF manager, also known as a sponsor, designs, develops, and launches the fund. The same person may manage the fund from day to day or partner with another person or firm to do the work.
The ETF manager must submit a detailed plan for the fund to the Securities and Exchange Commission (SEC) for its approval. This is an onerous process, although the regulatory rules, which date from 1940, have been updated to reflect the existence of ETFs.
The real money is due when the ETF is actually created. The ETF manager must buy and deposit all of the assets listed in the ETF. The manager will then receive a number of shares in the ETF that equal the value of the shares deposited. These are called "creation units."
Most ETFs are index funds but the reverse is not true. Many index funds are mutual funds, which do not trade on the exchanges as ETFs do. Competition from ETFs has generally caused mutual fund fees to decline.
Platforms to Create Your ETF
Clearly, creating a successful ETF requires expertise in fund management, marketing, and regulatory compliance, among other specialties.
There are web-based services that promise to help you build, launch, and manage an ETF. Among them are ETF Managers Group, Exchange Traded Concepts, and Alpha Architects.
Few people have both the expertise and the cash to create, market, and manage an ETF. But given the resources available now to the individual investor, almost anyone can create an ETF-like personal portfolio. And, who knows? If your investment ideas pass the test of time your mock ETF may grow up to be a real exchange-traded fund.
You can establish a portfolio of stocks that mirrors an index, and then buy and sell those stocks to maintain the weighting of the stocks in the index. It requires time and effort but can be affordable if you use a commission-free trading platform like Robinhood or TD Ameritrade.
The Stock Slices Option
The notion of building a personal ETF becomes more affordable with the availability of stock "slices." Brokerages like Robinhood and even Fidelity and Charles Schwab now allow investors to buy fractional shares in companies.
This means that you can create your personal ETF with fractional shares of stocks, even if one or more of the stocks on your list have a formidable price per share.
Still, if you are like most investors, you probably would prefer to diversify your portfolio without being required to continuously buy and sell securities. If that's the case, then purchasing shares in an existing ETF is likely the most suitable choice.
387 active ETFs were launched in 2023, while 116 passive ETFs were launched in 2023.
Challenges of Creating Your Own ETF
With the process and steps behind us, let's discuss and summarize some of the challenges you'll come across should you set up your own ETF.
- Regulatory Compliance: Navigating the regulatory landscape involves meeting the legal requirements set by the SEC. You'll have thorough documentation, disclosure, and adherence rules to comply with related to fund structure, disclosures, marketing, and reporting.
- Initial Capital and Expenses: Like we talked about before, launching an ETF requires a substantial amount of capital. This is not just for the initial investment but for the legal and regulatory fees.
- Liquidity and Trading Volume: Achieving sufficient liquidity is vital to the longevity of the ETF. Without shares available to trade, it'll be more difficult to execute trades (or execute trades as more reasonable bid-ask spreads).
- Market Competition: Chances are there will be similar ETFs that track indices you want to track. You'll have to effectively differentiate your ETF and clearly communicate its value proposition if you want to attract outside money.
- Operational Complexity: Running an ETF involves a number of operational processes including handling the creation and redemption of shares, managing the portfolio, and ensuring accurate tracking of the index. You'll need to set up an infrastructure that can allow for the ETF to function.
Is It Possible to Create Your Own ETF?
If you have the financial expertise and a stash of seed money, creating an ETF is within your reach. You can even pay a web-based company to guide you through the process and manage your fund for you.
How Do ETFs Get Created?
You could create the equivalent of an ETF on your own, by mimicking the holdings in an existing ETF. For example, the Dirextion NASDAQ-100 Equal-Weighted Index ETF (QQQE) mirrors the NASDAQ 100. The list of stocks that are tracked by the NASDAQ 100, and their relative weights in the index, are readily available online.
Do ETFs Earn Dividends?
Many ETFs pay dividends. An ETF invests in all of the assets listed in a specific index. If those stocks, bonds, or other assets pay dividends, the ETF collects the dividends and passes them along to their shareholders.
How Much Does It Cost to Start an ETF?
As you might expect, creating an ETF doesn't come cheap. The website ETF.com breaks down expenses into a number of categories:
- $100,000 to $500,000 for SEC regulation costs. The lower end is for plain-vanilla funds that don't stray from the basic strategy of mimicking a single large-cap index.
- About $2.5 million to seed the ETF with initial purchases of assets.
- About $200,000 a year to run and properly oversee the fund.
- A fraction of the fund's value to list it on an exchange. This cost, of course, grows with the value of the fund.
Those are the basics, but they don't include costs like legal fees and marketing expenses, which can be significant.
The Bottom Line
Launching an ETF is possible for an individual investor but it takes deep pockets and a great deal of work. The popularity of these funds has led to creation of a number of services that help investors create, list, market, and manage ETFs.
Those who lack the resources can build a virtual ETF on their own, mimicking an index to create their own personal portfolios.
As an expert in finance and investment, with a deep understanding of exchange-traded funds (ETFs), I can provide valuable insights into the article's concepts. My expertise is demonstrated through a comprehensive understanding of the financial industry, including the intricate processes involved in launching and managing ETFs.
The article discusses the idea of creating and managing one's own ETF, highlighting the benefits, challenges, and key considerations associated with such a venture. Let's break down the concepts used in the article:
Introduction to ETFs:
- ETFs are investment vehicles that track a selection of stocks or other assets, often mirroring a specific index, sector, or commodity.
- One significant advantage of ETFs is their ability to offer diversification, allowing investors exposure to a broad range of assets through a single investment.
Creating an ETF:
- Starting an ETF requires significant startup capital and financial expertise.
- ETFs can be passively managed, tracking a set of stocks based on an index, or actively managed, similar to mutual funds.
- Key considerations for designing an ETF include asset class, market capitalization, market sector, and setting the annual fee (expense ratio).
The Process of Creating an ETF:
- The ETF manager, also known as a sponsor, designs, develops, and launches the fund.
- A detailed plan must be submitted to the Securities and Exchange Commission (SEC) for approval.
- The manager purchases and deposits assets into the ETF, receiving "creation units" in return.
Platforms to Create Your ETF:
- Web-based services such as ETF Managers Group, Exchange Traded Concepts, and Alpha Architects can assist in building, launching, and managing an ETF.
Other Options for Investors:
- Individuals lacking the expertise and capital to create an ETF can build a virtual ETF by mimicking an index using commission-free trading platforms.
- The availability of stock "slices" allows investors to buy fractional shares, making the creation of a personal ETF more affordable.
Challenges of Creating Your Own ETF:
- Regulatory compliance, initial capital requirements, liquidity, market competition, and operational complexity are key challenges.
- Differentiating the ETF and effectively communicating its value proposition is crucial.
FAQs about ETFs:
- Explains that ETFs can earn dividends as they invest in assets that pay dividends.
- Outlines the costs involved in starting an ETF, including SEC regulation costs, seed capital, annual expenses, and exchange listing costs.
Conclusion - The Bottom Line:
- Launching an ETF is possible for individual investors but requires deep pockets and significant effort.
- Services are available to help investors create, list, market, and manage ETFs.
- Alternatively, investors can build virtual ETFs by mimicking existing indices.
In summary, the article provides a comprehensive overview of the process, considerations, and challenges associated with creating and managing an ETF, catering to both experienced investors and those exploring alternative investment options.