Lee Kranefuss, ‎Executive-in-Residence at Warburg Pincus, talks about the motivation to buy the majority of Source ETF, Pincus′ plans with the acquired firm and the future trends in the ETF industry in the US and Europe.

BY MARTIN RAAB

Lee, your company – Warburg Pincus – recently bought the majority of Source ETF. What was the motivation for this acquisition of an European ETF provider?

We believe that ETFs are an attractive investment space.  The industry is at an inflection point with tremendous opportunity for explosive growth over the next couple of years.  As you know, I have worked in the ETF space for many years and it is rare to find companies such as Source which is a real pearl.  Source has an excellent track record and very impressive growth figures.   In addition, Source benefits from a number of unique products from select partners all benefitting from Source’s multi-partner platform.  I have known Ted Hood and the management team for many years and they are one of the best and most professional that I have come across.

Source is the only provider I know of, globally, that has built their platform and products on the learnings of the 2008 crisis to minimize shareholder risk through a diversified, transparent, multiparty risk diversification approach managed by an independent fiduciary.  This is very powerful.

How did the shareholders (incl. BofA/Merrill Lynch, J.P Morgan, Nomura, Morgan Stanley and Goldman Sachs) react to your offer?

We have a good relationship with the existing shareholders.  It is not really for me to speak on behalf of the shareholders but clearly there is a sense that Source would benefit from becoming more independent and the additional capital provided by Warburg Pincus will help fuel further growth. The fact that the existing shareholders retained stakes in Source is positive sign, we look forward to using the existing synergies and rapidly accelerating Source’s growth together.

…so they remain as Source´s shareholders?

Yes, just with a reduced share but will still be Authorized Participants (APs) and counterparties for the Source product suite.   Clearly, it’s always a good sign if the existing shareholders want to stay with the company.

How would you categorize this private equity investment – late stage?

Warburg Pincus are private equity investors focused on growth.  For them, this is very much a growth oriented-investment.

Does Warburg Pincus have still some ETF-related targets on its shopping list?

The ETF market is ripe for consolidation and it is likely that Source will play a lead in this consolidation.  Any further investment by Warburg Pincus in this sector is likely to be through Source. The robustness of Source’s operational infrastructure meant that they were a natural choice as a platform onto which a larger ETF business can be grown or if needed, consolidated.

Did you primarily target a non-US-connected ETF issuer?

We looked at a number of ETF companies globally.  We came up with a shortlist of what we thought were “hot candidates” in Europe and globally.  Source impressed us the most with its strong track-record, product offering and management team.

Does this – vice-versa – mean that the growth in the US ETF market might decelerate?

It is a very different market framework in the US to Europe.  There is still some growth in the US but we see more potential overseas.

As always, in the case of strategic investment, there were larger plans for the business. What are your plans with Source?

Primarily we are looking to continue to drive growth and focus on new product development, expanding the range of Asset managers and content providers on the Source platform.  We also think there is scope for Source to play a role in the widely anticipated industry consolidation.

Any changes planned on the product setup of Source ETFs (physical vs. synthetic) or involved service providers (i.e. Assénagon etc.)?

No, Source’s stance with the structure of ETPs has been very pragmatic. Source offers a selection of products in physical form and others which use synthetic replication. The choice to deliver a strategy in either form is down to a variety of factors including the underlying assets and specific market dynamics. Source offers the appropriate replication method where it is efficient and in an investor’s best interests to do so.

When do you expect to see the final decision of the UK regulators (for the Source deal)?

It is always difficult to second guess the regulators.  We would hope that it will not take longer than a couple of months.  We do not see an issue with the transaction from a regulatory perspective as the investment by Warburg Pincus does not change the competitive dynamics of the market.

You personally will relocate to London?

Throughout my decade and a half in the ETF business, I have travelled actively around the globe as this is a truly global business.  I will certainly be spending a lot of time in London in the coming years.

Finally, which trends you see within the US and European ETF market?

There is a very different market framework in the US compared to Europe.  Nevertheless, both regions will continue to see significant growth and valuable asset flows. In the U.S. the big providers will continue to grow, but there will be room for specialized and strategic entrants who bring true investment opportunities that are not duplicative.  In Europe, there will be a rationalization of the industry.  In addition, customers will come to realize the synthetic vs. physical debate is not the right one: In time, customers will demand major players migrate to a platform and product approach which is based upon diversifying counterparty risk via a diversified,  post-2008 platform.  Aside from Source, todays participants in the European ETF market expose shareholders to non-transparent or undiversified risk, whether the funds are physical or synthetic.  This will occur first in Europe, but the issue should arise in the U.S. in time as well.