In January, Warburg Pincus announced it was acquiring a majority stake in Source, a five-year-old asset manager that has rapidly developed a unique position among Europes Exchange Traded Product (ETP) providers. The acquisition, expected to close in April, brings together two firms that have similar philosophies of partnering to develop unique expertise in different segments of the market.
Warburg Pincus is acquiring Source from an $11 billion fund, providing not only the financial muscle to further power Sources organic growth, but also giving it access to funds that it could draw from to potentially grow through acquisition. With the additional firepower behind it, Source aims to carve out an even bigger space for itself in the ETF market.
No one is directly challenging BlackRock for the number one or even the number two spot. We feel that we want to be the guys to challenge them for that, said Michael John Lytle, Sources chief development officer. (BlackRock has a 50 percent share of Europes ETF market, according to figures from data provider ETFGI.) We think that our combination of a dynamic approach to the market, rapid growth, a willingness to innovate, take new tacks and be relatively aggressive-we think that can work. The only thing that was missing was more investment behind it.
At this point, at $15 billion in assets under management, Source is admittedly small in comparison with the giants. But Lytle points out that, while it is still early days, the firms pace of growth has hovered near top-tier levels. In 2012, Source was second behind iShares in raising assets, and in 2013 it was among the top four. Ultimately its not just about the inflows for that year. You have to sum all those up and the total assets need to grow very rapidly, Lytle said. So we need to outgrow everyone else in order to catch up.
Origins
The two firms similar approaches to partnerships may be what brought Warburg Pincus and Source together, and what makes them compatible. In the case of Source, a partnership strategy has resulted in collaborations with Pimco, to be the distributor of Pimcos fixed income ETFs in the European market, and Man Group, the worlds largest publicly traded hedge fund firm, to create a performance equity product, to list a couple of its highest-profile arrangements.
In the case of Warburg Pincus, its partnership strategy involves hiring proven sector leaders as executives-in-residence to identify and develop opportunities in different corners of the market. In the ETF space, Warburg Pincus executive-in-residence is Lee Kranefuss, the original architect and CEO of iShares at Barclays Global Investors, which he built into the largest global ETF platform, managing $600 billion in assets when it was acquired by BlackRock at the end of 2009. Kranefuss will become executive chairman of Source. Sources existing shareholders-BofA Merrill Lynch, Goldman Sachs, J.P. Morgan, Morgan Stanley and Nomura-will continue to hold minority stakes.
For Source, the concept of multiple partnerships is part of its genesis, based on opportunities it saw in the way the European ETF market was unfolding when the company was first founded. Prior to Sources launch in 2009, there were ETF products in Europe offered by asset managers and by investment banks. The investment banks had interesting products, but they were vertically integrated products with a lot of single-counterparty risk. As Sources founders hailed from investment banks (Lytle and CEO Ted Hood are from Morgan Stanley, and chief strategy officer Peter Thompson comes from Goldman Sachs), they decided upon a hybrid model: an asset manager backed by multiple investment banks with equity stakes. We decided there is an opportunity to create a hybrid model, which is an independent asset manager, but one that is completely up to speed on what is going on in the sales and trading market and that can take advantage of all these elements of value that the investment banks are trying to take to the table, Lytle said. But we wanted to do it in an independent, multi-counterparty way to avoid undue exposure to any one entity.
Actively Managed ETFs
Sources policy of strategic partnerships (and Lytle stressed that the firm is selective in its partnerships and not a white-labeling platform) has brought it into what was initially relatively uncharted ETF territory. Where ETFs originally tracked benchmarks, several of the ETFs that Source introduced veered from benchmarks to incorporate investment decisions, becoming what are known as actively managed ETFs.
When we launched our first active ETFs, people were a little surprised, and they thought, Do active and ETF really go together? Lytle says. Now people completely accept that active can be wrapped as an ETF. It just becomes the challenges for the manager of the product as to whether they are willing to give the level of transparency around the strategy. He added that some fund managers might have concerns about the potential overlap of distribution between traditional fund sales and their ETF sales.
With Pimco, Source has four actively managed ETFs, two of which are $1 billion or more. Three ETFs that Source distributes for Man Group are essentially actively managed as well, though algorithms, rather than humans, are selecting the stocks. Source has raised $1 billion in those strategies as well.
Weve got pretty good evidence that active and ETF can work together, but we are one of the few that have raised any meaningful assets in active ETFs, so we think there is a little bit of special insight needed to make it work, Lytle said.
Europe Rising
While Source has big ambitions, plans are to continue to focus its efforts on the European ETF market. We think there is significant opportunity in Europe for a number of reasons, Lytle said, noting that the European ETF market started in 2000, seven years after the ETF market began in the U.S.
If you plot Europe growth versus U.S. growth basing to year zero, Europe is doing very well and growing faster than the U.S. did. But in the last seven years, the U.S. has gone through a hockey-stick growth where it has really taken off exponentially. We hope that happens in Europe and we want to help the industry do that, he said.
Part of the growth of the U.S. ETF market is because the share of assets invested in ETFs as compared with mutual funds has grown in the U.S. Europes ETF share has not yet made such strong inroads. Source expects ETFs have room to gain market share in Europe and predicts overall growth of European assets under management.
In fact, Europe appears to be attracting increasing interest at the moment. Europes ETF market saw a 20 percent jump in assets in 2013 to $395 billion, according to the Financial Times. In addition to the Warburg Pincus acquisition of Source, U.S.-based ETF provider WisdomTree plans to acquire U.K.-based Boost ETP, and Charles Schwab has admitted to having begun to explore Europes ETF market. U.S.-based ProShares says it is looking at opportunities outside the U.S. as well.
The European market and U.S. ETF markets operate differently, with U.S. ETF flow driven more by individual investors and the European market more institutionally driven, Lytle says. European investors do significant due diligence before approving ETFs and, as a result, an issuer may have to establish a footprint in the market to attract investment from institutional investors.
The growing interest in European ETFs may be a sign that the market is at an inflection point. I think the barriers to entry in Europe are high and will only get higher still, Lytle said. Firms may want to try to get in now.
