ETF Expert Corner

ISE’s Kris Monaco on ETF Growth & Innovation

April 19th, 2016 by ETF Store Staff

Kris Monaco, Head of ISE ETF Ventures, discusses the incredible innovation occurring in the ETF space and how investors benefit.  ISE partners with a number of ETF providers and has been involved in one of the most successful ETF launches ever, the PureFunds Cyber Security ETF (HACK).



Transcript

You can listen to our interview with Kris Monaco by using the above media player or enjoy a full transcription of the interview below.

Nate Geraci: I'm now pleased to welcome to the program Kris Monaco, head of ISE ETF Ventures. ISE sits in a unique position, they partner with ETF providers on everything from creating the index an ETF might track, to providing funding for new ETFs and even marketing support. ISE is behind a number of popular ETFs, perhaps most notably the PureFunds ISE Cyber Security ETF which had one of the most successful launches in ETF history. They've also provided support in a variety of ways to ETFs like the AlphaClone Alternative Alpha ETF, the Loncar Cancer Immunotherapy ETF, and an ETF we spotlighted just last week, the Tierra XP Latin America Real Estate ETF. All together ISE has over thirty proprietary indexes, with some twenty exchange traded products tracking those indexes. As I mentioned earlier Kris, more than most people really has a front row seat to the incredible innovation incurring in ETFs. We're very pleased to have Kris join us via phone from New York today. Kris, welcome to The ETF Store Show.

Kris Monaco: Thank you, good morning, thanks for having me.

Nate Geraci: Well you know Kris my sense is that many of our listeners are probably unfamiliar with ISE and ISE ETF Ventures. You operate somewhat in the background, I guess to start here today can you tell us a little bit about your background, the company, and maybe how ISE became involved in ETFs?

Kris Monaco: I was an engineer by training, and formal live practice as an engineer. Went to school for it from high school all the way through college, but my passion was certainly in trading. I recall when I was very young, my dad loved to invest in pink sheet stocks, so the riskiest of the risky stocks. I would help him track those stock prices, he would bring home the book. Back then there was nothing computerized, and everything was printed on pink sheets of paper. That's why they called them pink sheets. Indeed I would look those up and track the stocks, and that's how I first got my taste of it. Over the years, eventually was old enough to start my first account, which was a dial up modem account and you had to make sure that you didn't hit the send button too many times because you would buy yourself that many times. Those were the early days of trading, over the years of engineering that's where my passion really was. I decided to make a big leap and left engineering and joined finance. I guess you could say it's because of the engineering aspect of it that I still enjoy, where instead of building things for people, whether they're driving, or using them, or riding on them, and taking the case of engineering and civil engineering. In this case it's more financial engineering I guess you could say, and we're now developing products that people are using and benefiting from every day.

I joined ISE in 2002, and back then it was a virtually still a startup focusing on equity options, options on individual stocks. ISE is an exchange operator, ISE now operates three option exchanges but at that time the focus was to expand the number and types of listings on the exchange. We thought about what was highly adjacent to the equity options space and thought about equity indexes, and creating our own, and we started to do just that. We started to create indexes that focused purely on natural gas suppliers, we focused on water companies, we focused on even alcohol, tobacco, and gaming stocks. The index that you mentioned and the one that's had a lot of success for us, thankfully, I knock on wood every time we discuss it, is the cyber security index. That I always use as a great example of the evolution of an ETF, but that was one that was a home grown index, and we launched that I think just at the right time, and thankfully very successful for us. Now ISE, still an exchange operator as you mentioned, still also provides not only the underlying indexes but also financing and marketing support to launch new products as well. We have a lot of fun coming up with new ideas, but it is also a lot of work.

Nate Geraci: Kris it's interesting, we've covered easily hundreds of ETFs on this show. Usually the focus is on the end product, the ETFs themselves and how investors might use them in their portfolios. Obviously you're involved more in the development of ETFs, you help take ETFs all the way from idea stage to the finished product, and perhaps even beyond that in terms of marketing support. Can you maybe walk us through the process of how a new ETF comes to market? How does an ETF like the PureFunds Cyber Security ETF come to be?

Kris Monaco: It really is a journey and sometimes an index will take a lot of different roads until it first becomes commercialized. The cyber security index originally started as a homeland security index where cyber was one of the components within it. We launched that well over ten years ago but didn't get much traction as a derivative product or as an ETF. Perhaps it was before all the headlines of hack attacks and cyber events, so we noticed that over the subsequent years that news was starting to grow, and hacking was unfortunately becoming more prominent in the news. We decided to focus specifically on that one, launched the index in late 2014 with the goal of creating an ETF. The way we do it is we line up all of the partners associated with making sure the ETF is run on a day to day basis, and so we are not doing it ourselves. We talked to firms that are the advisor, or the ones that are managing the portfolio, the ones that are helping on the marketing side. We put it all together as a venture firm you could say within the ETF space, and then helped launch the product and also helped promote it subsequent to its launch.

Nate Geraci: Kris in your mind what makes for a good ETF? What types of ideas does ISE typically like to support?

Kris Monaco: Well you know sometimes I feel like there are so many different ideas that have yet to be developed and it's very exciting. It really starts with solving a problem in the industry, I think that's the best idea. If there's a problem in the industry, if it's an access problem, a convenience problem, if somebody just doesn't have exposure to a certain asset class. Problems to me are opportunities, and if we can solve the problem by way of a new ETF, whether that's a package strategy or as I mentioned providing convenience to a specific strategy in one ticker, or access to a specific foreign market that investors wouldn't otherwise be able to get on their own, that's worth something to people. That's what we look for, if we're solving a problem in the industry and it can be done by way of an ETF, for us, we think is the best chances for success.

Jason Lank: Kris this is Jason Lank, I'm curious, are there any concepts or ideas that didn't work as an ETF that for whatever reason didn't make it to market? Maybe talk about some of the reasons why that might happen.

Kris Monaco: Yes, there are some ideas that don't make it to market, sometimes it's based just on unfortunate timing. If we have an idea in the market and we think that it's dependent on certain market conditions, and those market conditions deteriorate or they change abruptly then unfortunately that concept will still remain in the pipeline and likely de-prioritize. There are ones that do come to market and let's face it, we don't have a crystal ball, we do of course look at news, we look at what's going on in the industry, we look at competitive gaps in the product layout, and we think, we pick what are topical important ideas. Never the less some of them may not resonate strongly with investors and therefore we have to make some changes. Making some changes either directly to the index structure or even perhaps delisting the ETF at some point. In the end it's really all about the investor and we don't want people to suffer a product that's really not helping them in their portfolio.

Nate Geraci: Again we're visiting with Kris Monaco, head of ISE ETF Ventures. Kris a big part of what your firm does is to help promote and market ETFs and in the mutual fund world brokers receive commissions for pushing certain mutual funds. In other words mutual fund companies will pay for shelf spaces and brokers are financially incentivized to sell certain mutual funds but ETFs don't pay commissions to brokers. I'm curious, from a marketing perspective how do you help ensure ETFs get a fair shake?

Kris Monaco: It's very difficult, there's a lot of ETFs out there, and I think every one of them should have their chance. The goal for us is to make sure people know that the product is out there, it's an awareness issue. I think there's a lot of great media sites and shows like yours that highlight great new products, I think that's a big part of it. What we do is we focus on the underlying concept, we talk about where we think this fits in a virtual portfolio. We have our marketing team and whole sellers, these are registered sales people that go out and actively promote the product, talk to professional investors about where the particular product fits in a portfolio. It's also leveraging the existing news that's going on, when people read about hacking events, and cyber security attacks, or people hear about drones, or how drone technology is increasing with video game technology. These are the things that we look for and we actually leverage to make sure that people are aware that, you know what, there's a very specific well thought out, well researched solution to getting exposure to that particular space.

Jason Lank: Kris you mentioned that you pay attention to the news, what has been in the news as well recently is the new department of labor ruling regarding putting client interest first for investment advisors. There's certainly a lot of discussion and debate about that, how does that type of ruling effect the ETF space in your opinion and in your firm in particular?

Kris Monaco: Well I think, there's a lot in there but I think the net of it all will be positive for the ETF industry. I think that with the rise of many fee based advisors that there is no potential for conflict of interest because there's no compensation directly from the issuer or in terms of what's called a 12b-1 fee, or a marketing fee, and because of that structure I think it will increase usage across different distribution channels. Meaning that firms that were once predominantly commission based may switch to being fee based. That just may be a natural course of action considering the changes from a regulatory perspective. It makes sense for a lot of investors to have that type of relationship with their advisor where the advisor is purely being compensated on the amounts of assets that the client is bringing to them rather than the product that's being pitched through them.

Nate Geraci: Kris, going back to ETF innovation, we've talked a lot on this program about how ETFs have certainly helped to democratize investing. They've given investors access to markets and strategies they simply couldn't have dreamed of accessing, even just a few short years ago, and of course ETFs can offer benefits like lower cost, and tax efficiency, and transparency. We've also talked about how this innovation can be a bit of a double edged sword because there are lot of niche ETFs, and some more complex ETFs on the market. How do you view those?

Kris Monaco: Well this a great question and I love talking about it because I look at some older statistics of the mutual fund industry and if you were to ask someone in the mid 1990's when there were about four thousand mutual funds, "How many more could there be?" I'd think if you told them there would be double that amount in ten years that person would think you're crazy, yet here we are and there's over eight thousand mutual funds. Not that they're all doing incredibly well, of course there are many of them that are not, but it's all about letting the marketplace decide what's important to them. Now of course there’s an effort that goes with natural product but in the end I think there could be potentially thousands of more ETFs out there, the marketplace will decide which one is important, which ones aren't. I also think about an old saying, I'm not sure if it's attributable to someone that worked at the U.S. patent office at the turn of the last century that said, "Anything that can be invented has been invented." It's certainly not the case and you can see it with new ETFs launching almost every day.

Jason Lank: Kris one of the intellectual debates we have at our shop revolves around the ETF strategy, the individual ETF. One line of thinking might be one of the reasons it might outperform is that this concept is hard to implement and maybe not transparent. Well we know ETFs have changed that, we now have a variety of strategies available for a nominal trade ticket. Is there any concern in the industry that once a concept is package and put in a box that the outperformance might disappear?

Kris Monaco: Well you can never guarantee performance as we all know, but there are certain strategies that can be codified in the form of an index and I think that's the beauty of the ETF. The beauty of the ETF is that, I feel that anybody that says they're an active manager, even if they say that, they're really following a set of rules that can be customized to become eventually an index. I feel that a lot of these concepts and strategies are very well thought out, and even though they can't guarantee future performance somebody can read an index methodology, read the prospectus and understand exactly what this index is supposed to do. Some of them are more complex than others, I agree, but the information is there for investors to read and they can get exposure to strategies that would otherwise either be out of their reach because they may not have an account that enables them to trade derivatives or it's a convenience issue. Why trade a multi legged derivative strategy if you can buy it just as X, Y, Z ETF. I think that's really the important part there. It's reducing cost, it's reducing complexity, and it's enabling exposure and access to areas where investors didn't have that before.

Nate Geraci: Again we're visiting with Kris Monaco head of ISE ETF Ventures. Kris you mentioned obviously making sure the end investor understands the indexes that the ETF tracks. Are there other aspects of ETFs that you think the industry, which obviously includes both of us, needs to do a better job of educating investors on?

Kris Monaco: I think as much as the information is there, it's certainly in very heavy documents that perspectives can be light, it could be hundreds of pages, and an index methodology can be very complex as well. Some of the things I think about, and I think will eventually happen will be to come up with, you could say the equivalent of the nutrition facts label on an ETF. There are some high level statistics that I think would benefit people that if standardized correctly people can eventually do a deeper dive into the product, but it enables them to figure out exactly what this product is holding at any given time according to standardized statistics. I think that will grow, that will happen, and I think you'll eventually see a lot of them will be intuitive, they make a lot of sense. Even though it's out there it's not consolidated in one easy to read one page document, I think that will be coming.

Nate Geraci: As you look out over the next several years where do you see ETF innovation occurring? Are there certain areas or segments of the market that you think are prime for new ETFs?

Kris Monaco: I do, I mean I'm very bullish on the industry overall, I think that whenever you have a flexible wrapper like this, again it's going to provide people, any investor any access they want across the planet. I'm particularly interested in how people can have access to commodity prices. Eventually people will want to diversify their portfolios to other asset classes outside of equities. They're doing so now, and I think they'll do that in a way where it doesn't become completely dependent on futures contracts for example. I think they'll see more products that will be based on, potentially on physical commodities, on commodities that are growing, commodities of importance, maybe not in the U.S. but also overseas. I think we'll see more package strategies, so more sophisticated investors that are using options or futures in their portfolio but want a customized streamline way of doing it, may opt to do that as an ETF that again, provides that exposure for them in one ticker. I think we'll also see some folks that may not be using derivatives but like the fact that they're getting a diversified portfolio, again in that one ticker. It may be a mix of bonds, and equities, and commodities, and currencies within that ticker, and it's a one ticker solution for people that, they're just starting out, they're just beginning to save and they want a smart portfolio, they're not looking for something to manage on a day to day basis. I think we'll see more products like that as well.

Jason Lank: Kris ISE really appears to be in the sweet spot of this growth and innovation in our industry, and certainly the new department of labor rulings probably a tail wind as well. With all of the good news out there is there anything that keeps you up at night? Is there anything that your firm says, "These are clouds out there that might impact us someday?"

Kris Monaco: I think the biggest things that keep me up at night are the new ideas I have in my head that I want to build out. There are some things. I always think about liquidity, I think of market structure, how ETFs are being traded. There's great market making firms out there now, I think there needs to be more discussion on market microstructures side between exchanges and market participants, that's happening now as we speak. I think that's one area that could use some improvement but I'm happy to say that it appears that it's already ongoing.

Nate Geraci: Kris we have about two minutes left, you mentioned earlier that there could potentially be thousands of more ETFs to come to market. Where are we in the ETF grow cycle? Are we still early, do you think ETFs are beginning to mature now, where are we?

Kris Monaco: It's a mixed bag, I think overall, I hate to use the cliché, but we are in the early innings, I really do believe that. I think there are some pockets of the ETF industry that are mature. Let's face it, there are over sixty products that are ten basis points and cheaper in terms of expense ratio. Those are ones that are focusing on the areas that you would expect whether it's plain vanilla broad based domestic equity market exposure, small cap based on market cap. That has matured quite a bit and perhaps there's room for a product to go even lower but once you get below ten basis points I think from an individual investor point of view there's not much cost savings between the products. I do feel like that there is potential for even those products where there is heavy pricing pressure across the issue that are competing to have their products distributed in different channels, for example in the 401k channel. I also think there's a lot of opportunity for well researched, and even ones that require intensive research, to have their time. That's what we focus on, we like the heavy lift, we like the hard to structure and hard to research ideas because we think people are thinking about this and they want the convenience and the expertise associated with the underlying index and also the ETF. I think we're really in the early stages, not only from a distribution point of view but also from just a concept development point of view.

Nate Geraci: Well Kris on that note we'll have to leave it there. Boy, just a wonderful discussion today. We appreciate you taking the time to join us and we'd love to have you on the program again down the road. It's certainly an exciting time for both the industry and more importantly for investors. Again, thank you for joining us today.

Kris Monaco: Thank you for having me, always exciting, hope to talk soon.

Nate Geraci: That was Kris Monaco head of ISE ETF Ventures and if you go to ISE.com and click on the ETF Ventures tab there's some great information there on the different ETF providers ISE works with and how they work with them. Again, just go to ISE.com.