Sen Sharma says his company is currently in the process of deconstructing the duo’s formula in hopes of constructing a workable index.
“We looked through all of the materials they sent and we’re scoping it out to see if we can develop a solid methodology that we think makes sense and is potentially marketable as a fund,” he says.
Challenging Index
Indxx isn’t the first company—and that includes both index providers and ETF providers—to take a stab at Benvenuto and Harkin’s ETFS idea. “The bottom line is we couldn’t get a methodology to systematically select the companies,” says McLemore from Guggenheim.
Benvenuto and Harkin say index provider S Networks Global Indexes came to a similar conclusion. Harkin says he took the idea to his bosses at WisdomTree, but to no avail.
“They told me they didn’t think it could work for them but that we should take it to an indexer and keep going,” he notes.
Adds Benvenuto, “The bigger companies want very strong backtesting with quantitative-based results. This is a thematic concept where the results won’t be there for maybe a max of five years. It’s a forward-facing concept, so backtesting might not be the best way to test its investing merit.”
Sen Sharma sees room for another ETF industry-focused ETF on the market. “I think TETF is a great idea and a great product,” he says. “In a growing space—and the ETF industry is certainly a growing space—there’s enough potential room out there for more than one product."
Nonetheless, he adds, there’s no guarantee his team at Indxx will be able to develop a marketable index for ETFS. “I’d say that for every one product that we built that goes out on the market, there are probably 10 that don’t make the cut.”
Given that there’s an ETF for just about everything under the sun, it seems surprising that there wasn’t an ETF focused on the ETF ecosystem before the TETF fund launched in April. Venuto from Toroso says the big reason for that is simple—namely, it’s difficult to construct a viable index that tracks the industry.
“If you just do a back-of-the-envelope calculation of the U.S. ETF sponsors, take their AUM and cross reference that versus their expense ratios, the revenue generated from that is only about $6 billion,” Venuto explains. “Capturing a $6 billion part of the industry isn’t the primary objective—it’s all of the other things. We’re told that trading the ETF costs a lot more than the stated expense ratio. You have to look at spreads. Those spreads are being captured by the exchanges, the trading companies, and the custodians and platforms.
“The research and thought process behind building an index isn’t cheap,” he continues. “I have to bring in a team of researchers to figure this out. It just can’t be a team of researchers looking at data. It has to be industry insiders who understand how the industry works; who understand why Schwab is now the fifth-largest ETF issuer but the bulk of their ETF revenue isn’t from the expense ratio . . . it’s from custodial fees on its OneSource platform.”
Oh, and there’s one more potential roadblock on the road to making ETFS a viable product: Benvenuto and Harkin don’t have any money for product development.
“We have been going off the notion that the indexer or firm who was interested would develop the idea further,” Benvenuto says.
In the case of the TETF fund, Venuto says it cost six figures to develop the index and six figures to launch the product.
Next Stage
For now, Benvenuto and Harkin are content to let Indxx handle the ins and outs of their baby. But if that fails it won’t end their efforts to turn their idea into reality.
“If no one thinks they know how to do it, we’re learning how to code—the required coding language in order to provide your own indexing is called Python,” Harkin says.
Neither student enrolled at NYU to become an ETF meister—there are no classes for that. Nor do they know what it would mean for them if ETFS does become a U.S.-listed product.
“We’re not entirely sure what our involvement would be,” Benvenuto says. “I’m sure it’d be different depending on who would go with it. But we’ve been told we could possibly expect royalties or media exposure.”
At the very least, they say, the entire effort makes for good résumé fodder that’s probably far more valuable than any classroom experience.