The Invesco QQQ exchange-traded fund (the primary vehicle for investors who want to track the technology-focused Nasdaq 100 index) is arguably the most profitable ETF in the world.
Its $385 billion size, combined with its hefty 20-basis fee, means the company generates $770 million in annual revenue and ranks second in Morningstar’s global rankings, ahead of the SPDR S&P 500 ETF (SPY).
In fact, Triple Q alone generates nearly four times the return of Vanguard’s flagship S&P 500 ETF (VOO), which manages a record $774 billion. The Invesco ETF’s returns have outpaced those of Schroders, Janus Henderson, and Franklin Resources.
Its success has resulted in many nests. According to QQQ’s annual report, Nasdaq paid $205 million in license fees last year alone. Its trustee, Bank of New York Mellon, was handed a whopping $109 million. Thanks to the ETF’s extensive marketing, a surprising number of U.S. sports teams, leagues, and festivals have also enjoyed a QQQ windfall, worth $175 million last year alone.
However, there is one company that missed out on this bonanza. That’s Invesco. This is due to QQQ’s unusual “unit investment trust” structure (a vestige of the ETF industry’s origins in the primordial soup of the 1990s), rather than the now far more common open-ended ETF format.
Under this bizarre structure, any revenue left after paying expenses such as license fees and commission fees can only be used for marketing purposes.
This is extremely frustrating for Invesco. Given that the nearly $2 trillion asset manager generated only $538 million in net income last year, an annual payout matching the Nasdaq or BONY Mellon benefit would be a healthy boost to its bottom line. Instead, Invesco has been forced to resort to selling a series of cheap imitations of its flagship funds (QQQM, QQQS, QQJG, QQMG, etc.) that at least cover all of its fees.
Coincidentally, Christmas could come two months early for Invesco, with a vote scheduled next week that could correct this anomaly (and give investors a modest bonus). 🎉
This could prove to be such a big deal that the asset manager’s stock price soared when it proposed structural changes to QQQ.
But before we dig into the upcoming vote and what it means, let’s first take a quick look at how QQQ came to be and how it came to be adopted by Invesco.
For QQQ’s founder, Nasdaq Stock Market Inc., the issue of unit investment trusts probably didn’t matter too much. QQQ launched the fund in 1999 primarily as a way to promote its flagship index. (Fun fact — the company wasn’t even listed on the Nasdaq exchange, but on the rival American Stock Exchange, which at the time was the world leader in all things ETFy). Here, we talk about the birth of QQQ with its main founder, former Nasdaq Chief Marketing Officer John Jacobs.
QQQ’s troubles began in 2004, when it was licensed to Chicago-based PowerShares, then a flashy up-and-coming ETF boutique, and listed on the Nasdaq exchange.
Two years later, Invesco acquired PowerShares, and in the process absorbed Qs (as some fans called it), becoming the jewel in PowerShares’ crown with a whopping (at the time) $27 billion in assets under management.
Since then, QQQ has become synonymous with American technology stock success, increasing in size 14 times. It is now larger than the entire stock markets of Thailand, Norway, Poland and Malaysia.
Invesco’s scarce sponsorship fees have likewise skyrocketed in recent years. But that could change soon. On October 24, QQQ shareholders will vote on whether to convert the fund into a more modern open-end ETF.
The switcheroo also allows QQQ to reinvest pre-distribution dividends and lend securities for the first time, both activities that are illegal in unit trusts. As a sweetener, Invesco is also proposing to reduce fees paid by investors from 20 basis points to 18 basis points.
The biggest winner, of course, will be Invesco. Invesco will no longer need to funnel excess revenue into marketing, and will be able to seize its own profits and turn Qs into a cash cow. A filing with the Securities and Exchange Commission to “modernize and optimize” ETFs sheds light on this point.
Under the advisory agreement, the Trust’s marketing will be paid out of Invesco’s uniform fee, essentially reducing Invesco’s revenue (and profit potential).
Accordingly, while Invesco expects to continue to market the Trust to potential shareholders to the extent that it considers appropriate and beneficial to both the Trust (in the form of increasing the size of the Trust) and Invesco (in the form of increasing the assets of the Trust from which Invesco earns fees), Invesco will nevertheless have built-in disincentives to doing so, particularly when compared to the current status of the Trust.
Accordingly, the Trust’s overall scope of marketing (and the potential benefits of such marketing to existing shareholders) may be significantly reduced. However, Invesco believes that, at the Trust’s current size and scale, any potential adverse impact of reducing the Trust’s marketing activities will be more than offset by the benefits realized by shareholders through lower expense ratios (0.18% compared to 0.20%).
Invesco expects to cut its current marketing budget by nearly half from 5 to 6 basis points of assets to about 2 to 3 bps, or $60 million to $100 million, according to the filing.
In other words, about $100 million a year would be taken away from college football, baseball, the Women’s Basketball Hall of Fame, financial literacy, and more. . . Chefs. Also, you probably won’t see ads like this anymore.
“Marketing budgets have become so large that it’s difficult to spend them efficiently,” Alison Dukes, Invesco’s chief financial officer, said at a conference last month. That’s a good problem to have, but Invesco would rather use that money for something else.
The main hurdle is ensuring a vote of at least 50 percent of the shares on October 24, which is needed to reach a quorum and change the structure.
No wonder, then, that Invesco bombarded investors with emails imploring them to vote and retained Sodari Fund Services “to assist in soliciting additional proxies.”
Alphaville wonders if State Street Investment Management is paying close attention. The $661 billion SPY and its $40 billion sister SPDR Dow Jones Industrial Average ETF Trust are among the few ETFs that are still structured as unit trusts.
SPY’s annual report revealed $81 million in marketing expenses for the past financial year, out of a total cost of $473 million. But State Street has already found clever ways to keep much of its revenue in-house.
Its trustees gobbled up $232 million last year, nearly half of the total. Who is that mysterious trustee? Yes, none other than State Street Global Advisors Trust Company.
