When Maz Jadallah wanted to monetize his hedge fund position replication index by offering it as an exchange-traded fund, he sought help from what seems like an unusual place––the International Securities Exchange.

Based in New York City, ISE was the first all-electronic options exchange in the U.S. and now is the nation’s second-largest equity options exchange. While it generally hasn’t been known as a go-to place for anything ETF-related, ISE is no stranger to the ETF world. Its business development team has built more than 30 proprietary indexes that are tracked by 20 exchange-traded products from the likes of First Trust, Direxion and UBS.

Jadallah, founder and CEO of AlphaClone LLC, and ISE last May teamed up to roll out the AlphaClone Alternative Alpha ETF (ALFA), which tracks the AlphaClone Hedge Fund Long/Short Index. AlphaClone’s research focuses on combing through quarterly 13F public filings that disclose recently-reported holdings of hedge funds and institutional investors. The company’s index is based on a proprietary methodology that identifies high-conviction holdings of hedge funds it deems most worthy to follow.

“ISE is a well-established options exchange owned by Deutsche Börse that has deep pockets and credibility on Wall Street,” says Jadallah, explaining why he partnered with ISE on his ETF. “That gives the fund credibility with institutional investors.”

ISE’s partnership with San Francisco-based AlphaClone was the first in which it took an active role in bringing an ETP to market beyond simply creating an index that can be tracked. In January, ISE formally proclaimed its ETF ambitions when it announced that its product development group will now be known as ISE ETF Ventures, and that the group is going beyond index development to offer a range of financial, marketing and logistical assistance to create what it feels are innovative ETPs.

“We’re putting our money where our mouth is by putting our capital to work to create new products,” says Kris Monaco, head of ISE ETF Ventures. Regarding the AlphaClone ETF, he says ISE provided capital to launch and maintain the fund, in addition to providing marketing help.

The ALFA fund’s underlying index holds roughly 75 positions, and can adjust its outlook from being long-only during strong bull markets to being hedged at 50 percent long/50 percent short the S&P 500 Index during multi-month bear markets. The index is equal weighted but has an overlap bias that can give a constituent held by twice the number of managers twice the weight.

The fund’s average daily trading volume remains light, but it has attracted $10.7 million in assets and has gained nearly 23 percent in its first 10 months. Its expense ratio is 95 basis points.

Connections

ISE sees itself as a place where fund ideas can become reality. “Being an exchange, we have a unique position in the marketplace to share information that matches participants with each other and brings new products to market,” Monaco says.

Jadallah was introduced to Monaco by Garrett Stevens of Exchange Traded Concepts LLC, an outfit that helps bring ETFs to market and is the investment advisor for the ALFA fund. “He [Stevens] knew Kris was looking for innovative ideas,” Jadallah says.

Likewise, when PureFunds wanted to create natural resources-based ETFs, industry contacts put company CEO Paul Zimnisky in touch with Monaco and ISE. “It came down to us both having similar ambitions to launch niche natural resource products not yet covered by ETFs,” Zimnisky says. 

 

Madison, N.J.-based PureFunds came up with the concepts for three funds and their underlying indexes focused on gemstone production, the mining service industry and the silver exploration industry. ISE developed the indexes, and also provided financial, marketing and business development support for the PureFunds Diamond/Gemstone ETF (GEMS), PureFunds ISE Mining Service ETF (MSXX) and PureFunds ISE Junior Silver (Small Cap Miners/Explorers) ETF (SILJ) offerings.

All three funds were launched in late November, and all of them sport an expense ratio of 69 basis points. GEMS tracks the ISE Gemstone Index composed of international companies engaged in gemstone production or sales. MSXX tracks the ISE Mining Service Index comprised of companies that make and sell mining equipment, provide consulting and other services to miners, and well as miners themselves. SILJ tracks the ISE Junior Silver Index made up of small-cap silver mining and exploration companies.

The funds haven’t drawn much attention during their brief four-month existence, but Zimnisky says it’s a matter of getting the word out. “We knew it would be challenging bringing new products to market,” Zimnisky says. “These are unique funds, so there’s a need to educate people about how the companies and their industries make money.

“I view them as tactical products because they’re very specific in scope,” he continues. “We think our products could appeal to hard asset investors who want to diversify their physical gold or gold equities holdings.”

From a performance perspective, the PureFund’s mining services ETF has been the star of the group with a 13 percent gain since inception.

Big Plans

In February, ISE and fund provider IndexIQ announced they’ve teamed up to develop and launch funds focused on physical commodities. IndexIQ’s forte are index-based funds with strategies geared toward international, commodity and alternative investment-oriented strategies.

Monaco says ISE is keen on equity-based commodity exposure and on actual physical commodities. “I think there’s demand for physical commodities that can be securitized in a way that provides transparent pricing of shares in a listed product,” he notes.

Monaco adds that ISE wants to expand its ETF game beyond commodities-linked products. “We’re looking for anything that pushes the envelope in terms of how far ’40 Act products in a wrapper have gone so far,” he says. “We’re looking at options-based ideas that can be packaged into an ETF.”