Active ETFs: A Conversation with Bill Thomas, CEO of Grail Advisors

In July 2010, ActiveETFs | InFocus spoke with – Bill Thomas,CEO of Grail Advisors. Grail currently has seven Actively-Managed ETFs on the market and just recently released a white paper on fixed-income ETFs. Bill chats with us about fixed-income ETFs, Grail’s business model and key details on the mutual fund conversion process Grail Advisors is attempting with existing fund companies.

Shishir Nigam – ActiveETFs | InFocus: Bill, welcome to ActiveETFs | InFocus and thanks for joining us.

Bill Thomas – CEO, Grail Advisors: Thank you for having me, we’re glad to be here.

Shishir: Have you been satisfied with the level of growth and investor interest that Grail’s Active ETFs have seen?

Bill: Well, we’ve been very pleased with the level of interest. We knew that the asset growth was going to be a slow and steady race and it’s progressing as we expected. Certainly, we’re seeing greater growth in the fixed-income strategies because it’s been a fixed-income market. Just as in the mutual fund space, where assets have been flowing into fixed-income, that’s been the exact case for the ETF side as well. We’ve been pleased to have a full array of products and we’ll be announcing a couple more in a few weeks to complement what we have out there.

Shishir: Where do you see the Active ETFs heading in the next 2-3 years?

Bill: I am a firm believer that the Active ETF adoption is going to continue. If you look at the adoption in the passive space from 1993 to last year, where ETFs finally overtook mutual funds, my belief is that adoption will take place in about two-thirds of the time it did in the passive space. I think it’s just a better mechanism for investors. I think in the next years, you’re going to continue to see it be a real asset gatherer as compared to its mutual fund counterpart.

Shishir: How is your business model different from that of other players in the Active ETF space?

Bill: We feel very strongly that we want to deliver high quality investment managers in a format of an ETF. So we’re not out trying to bring on any strategy that knocks on the door and wants to launch as an ETF. We have a very strong due diligence program that makes sure when product goes through our screening process it’s something we’re very proud to have our name on. We also want to believe that it’s in a strategy and in a sector that’s going to gather assets and be successful overall. We’ve got a stringent process, if you will. I will tell you that we spend a lot of time with inbound calls with people saying they’ve got great ideas to launch in an ETF format. But we’re focused on delivering really in the core areas and meeting the needs of the client in this market environment.

Shishir: RiverPark Capital, a sub-advisor with Grail, has filed to launch its own Active ETF. Do you think more such managers might go straight to market with Active ETFs without utilizing Grail’s platform?

Bill: We’re excited about our relationship with RiverPark and we’re constantly looking at other opportunities collectively to launch a product as well. It just made sense for the strategies that they were thinking of bringing out and where we were going with our business, it made sense for them to consider launching those products on their own. With that said, we’re still looking to launch collective products between the two firms. It’s a great relationship and I think that the benefits that we can bring to the table in forms of the distribution breadth that we’ve got out on the street, the knowledge we’ve got in our wonderful service partners, we feel that we’ve really got a value add that helps out and gets people to market quickly.

Shishir: It has been reported by the Wall Street Journal that Grail is in talks to convert existing mutual funds into Active ETFs. Could you tell us more about this?

Bill: We’ve got several conversations going with a couple of fund companies where we’re looking to convert their existing mutual funds into an ETF format. That’ll be the first of its type in the active space, it has happened in the passive space. It’s a great way for investment management firms to move into the new technology of an ETF without having to start a whole new strategy and a track record and start gathering assets from dollar one. So we’re excited about that because of the benefits. These fund companies see the benefits the ETFs have for their shareholders and we see the benefits of being able to bring on board a conversion of assets and deliver in a more unique format of the ETF.

Shishir: What are the advantages of converting mutual funds into Active ETFs as opposed to starting a new Active ETF altogether?

Bill: The advantages are that you are able to move the track record from one structure over to the other. You’re able to migrate the assets from one structure to the other. You do need to proxy the existing shareholders of the mutual fund to convert to an ETF. But there the benefits are fairly substantial – typically the expense ratio will be lower because of the operating expenses of an ETF versus the operating expenses of a mutual fund. The tax efficiency, the liquidity and the transparency are wonderful benefits that ETF offer versus their mutual fund counterpart.

Shishir: Do you think there is enough investor demand yet to justify converting active mutual funds into Active ETFs?

Bill: Absolutely. The way I look at the mutual fund space, having spent my entire career there, is that it’s a very crowded marketplace. My belief is that those firms that move into the Active ETF marketplace at the beginning or convert existing strategies over are going to be rewarded with flows because of the benefits of the ETF structure. Just as you saw the early benefits of whether it was intermediary distribution in the load world or no-load distributions through the platforms – those early adopters were rewarded with assets and it’s perfect because it’s a less competitive environment. There’s not a doubt in my mind that it will be just as competitive here shortly as it is in the mutual fund space.

Shishir: From a mutual fund provider’s perspective, why would they have an incentive to convert their fund into an ETF when they can earn higher fees from the existing mutual fund investors?

Bill: Well, the fee structure is the same. The investment management fee is the same to the fund company. I think that’s one of the misconceptions about actively-managed ETFs is that to do this, the investment management fee is lower in an ETF than it would be in a mutual fund. The benefit of doing this is that the management fee remains the same to the investment management firm. It’s actually the operating expense is how you’re able to get a lower total expense to the client – lower in an ETF versus a mutual fund. So that’s a revenue-neutral move for the money manager, however it’s very positive for the shareholder.

Shishir: How would conversion be different from the issuance of a new ETF fund class of an existing active mutual fund, a process which Vanguard has under patent?

Bill: This would not be a share class of an existing mutual fund. This would be an actual conversion of the product from a mutual fund format to an ETF format. So the mutual fund goes away and becomes an ETF. It would not be a share class and therefore would not be at all similar to what Vanguard has done.

Shishir: What kind of strategies is Grail looking to bring to market in the future through Active ETFs?

Bill: As I mentioned before, we’re in the process of finalizing agreements with two more fixed-income firms. We’ll be announcing them in the next 2-4 weeks and we’re excited about not only the strategies that they’re looking to bring but also the depth and breadth of the firms and the power behind them. And then we’ve also got some strategies that we’re working on in the next couple of months that are more international in scope and we’re excited about that type of opportunity especially when you look at how important international and global exposure is in client portfolios. So we’re running very fast here at Grail Advisors.

Shishir: That’s fantastic. Thanks a lot Bill for joining us and we wish you all the best.

Bill: Thank you very much, I’m glad to be here. Thanks for having us.