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New ETFs face more skepticism from financiers

NEW YORK, June 9 (Reuters) - After a decade of aggressive expansion, the U.S. exchange-traded fund industry may be bumping up against a ceiling: Investment firms that have seeded thousands of funds since the 1990s are balking when asked to finance more.

While they have not turned off the tap just yet, ETF capital providers, such as Cantor Fitzgerald LP and Esposito Securities LLC, say that after a bout of ETF launches - some that have failed to attract active trading - they are more insistent on proof of a marketing strategy before they say yes.

Fund issuers like Guggenheim Investments and Summit Global Management Inc are working harder and waiting longer for the backing of sponsors that will enable them to go to market.

Capital providers are more often backing ETFs with less money, and many now come to market with as little as $2.5 million while bigger ETFs and many in years’ past had $25 million to $50 million behind them.

“I don’t think you’re seeing a ton of new seed capital,” said William Belden, head of ETF business development at Guggenheim. The top-ten U.S. ETF manager by assets delayed at least one fund this year while seeking seed capital and funders are more likely now to respond to new product ideas with criticism than they were before, Belden said.

San Diego, California-based Summit lined up regulatory approvals and investors for a new water-infrastructure ETF and promised some of its own funds to get the ETF off the ground, but after a month of shopping it around has been unable to attract a “lead” market maker to buy and distribute first shares of the Summit Water Infrastructure Multifactor ETF.

“We haven’t heard any no’s necessarily, but we just haven’t heard any yeses yet,” said Summit managing director Matthew Dickerson. “It’s frustrating.”

ETFs may be a victim of their own success. Seed capital is traditionally provided by market makers that float a fund and collect money as they sell the shares to new investors. As the shares sell off, they recycle the earnings to seed other funds.

While fund issuers can put up their own money, they usually are not permitted to be market makers for their own funds.

Now, with 277 U.S. ETFs launched over the last year, up from 193 in the prior-year period, market makers already have millions of dollars tied up in fledgling ETFs and it is taking them longer to get the money back.

A funder in recent years could expect to get its seed capital returned within two months of a launch.

Now that average has crept up to six months or longer, said a seed provider.

Mark Esposito, president at Esposito Securities LLC, said he is now waiting over a year to get seed capital returned from some funds.

The growing number of “zombie ETFs”, those that are issued and barely trade, contributes to the lack of money available for new funds.

Twenty-eight percent of U.S.-listed exchange-traded products traded fewer than 5,000 shares a day on average over the last six months, according to XTF, a London Stock Exchange Group PLC unit that did not include leveraged ETFs in its analysis. That compares with 20 percent of the funds two years ago and makes potential funders wary.

“You don’t want a bunch of duds out there,” said Esposito.

While he has long declined more proposals than he accepts, Esposito said he has been more likely to turn down proposals in recent months because of the amount of money dedicated to existing ETFs and the unreadiness of newly proposed funds.

One proposed ETF he refused to seed would have tracked Mongolian markets. Esposito said the idea was untested and may have run into difficulty raising assets or tracking a small, emerging market.

Reginald Browne, senior managing director at Cantor Fitzgerald LP, has been called “the Godfather of ETFs” and says he has helped bring a quarter of U.S. ETFs to market.

But even he is diving deeper into prospects’ fundraising strategy before putting up money, asking questions like how issuers plan to attract assets, whether there is a similar ETF on the market, if the issuer has existing clients that intend to buy the ETF and how long those clients will hold the fund.

After years of zippy growth in ETFs, that scrutiny might help, as long as it does not choke off good ideas, some industry players said.

“Perhaps we’re getting overheated with the number of products coming to market,” said Michael Akins, ETF chief at fund issuer ALPS Advisors Inc. “But you don’t want to limit innovation.” (Reporting by Trevor Hunnicutt; Editing by Linda Stern and Meredith Mazzilli)

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