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Implementing Investment Decisions with Exchange Traded Products Netherlands CFA conference PowerPoint Presentation
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Implementing Investment Decisions with Exchange Traded Products Netherlands CFA conference

Implementing Investment Decisions with Exchange Traded Products Netherlands CFA conference

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Implementing Investment Decisions with Exchange Traded Products Netherlands CFA conference

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  1. Implementing Investment Decisions with Exchange Traded ProductsNetherlands CFA conference 21st November 2012

  2. Table of Contents • Introduction • Why is exchange traded product implementation important? • Main methods of implementation • Case Studies • Optimisation Techniques

  3. Introduction

  4. Introduction and overview • Kris Walesby, Head of Capital Markets for ETF Securities • Responsible for Sell-Side relationships • Implementation, why it’s important and why it will grow in importance • Why implementation is important • Main methods for implementation • Case Studies • Optimisation Techniques • Questions and Answers

  5. Why is ETP implementation so important?

  6. The Great African Migration • Annual Event – Tanzania to Kenya • 1,800 miles • 1.5 m Wildebeest, 300k Zebra • Grumeti river • Not possible to avoid • To get to the fertile plains • And to get back

  7. Investment Decision Lifecycle Asset allocation decision Product selection Implementation Rebalance Exit Initial Total Cost Of Ownership

  8. Don’t Just Look At The Headline Fee • Investors naturally focus on headline fees - TERs • However there are other considerations, including • Rebalancing costs • Swap fee • Licensing fee • Implementation costs Implementation costs are becoming increasingly recognised by European ETP investors as one of the most important aspects to focus on

  9. The Importance of Time Horizons • Implementation is always important • However time horizons dictate the relative importance of implementation to the portfolio manager

  10. Example European ETPs – One Year Time Horizon

  11. Example European ETPs – One Month Time Horizon

  12. Main Implementation Methods

  13. Main Methods for Implementation

  14. ETPs are priced with reference to their underlyingHowever there are other elements to consider too • What does this mean in practice? Four main elements to an ETP price: • Underlying spread • Level of risk • Creation/Redemption costs • Existing Inventory – This acts as a price reducer Existing inventory Offer Price: - $25.50 Creation spread Risk spread Underlying spread Mid Price: - $25.00 Bid Price : - $24.50

  15. Main Methods for Implementation: On Exchange • Advantages • Anonymous • Centrally cleared • Usually cheap • Usually multiple counterparties • Disadvantages • Orderbooks can be shallow • No direct recourse to market maker

  16. Main Methods for Implementation: OTC @ Risk • Advantages • Large blocks at one price • Direct recourse to market maker • Disadvantages • Counterparty risk • Credit Lines need to be in place • Not anonymous

  17. Main Methods for Implementation: OTC @ NAV • Advantages • No market risk • Paid commissions for little work • Achieve NAV • Lower cost than a risk trade (usually) • Disadvantages • No opportunity to price at risk • Negative intraday price move • No possibility to “get inside spread of underlying” Market Maker Client

  18. Optimising Portfolio Implemetation

  19. Suggestions for Optimising Portfolio Implementation • Use limit orders where possible • Don’t judge the potential liquidity by looking at historical volumes • Check the trading times of the underlying • Don’t compare closing price to NAV • iNAVs are often useful but not always Capital Markets teams:- a critical aid to optimising implementation

  20. Case Studies: Trading On Exchange

  21. Trading ETPs on ExchangeExample: State Street Euro Corporate Bond (SYBC GY Equity) • Market makers compete with each other to provide the lowest price for an investor to buy at (Ask) and the highest price to sell at (Bid) • Within these prices the market makers have already included: • The spread of the underlying • Risk that they may be wrong • Existing inventory • Implied cost of creating and redeeming • In this case the “top of the order book” is a spread of 15 basis points or 0.15% = (53.67 – 53.59)/53.59 * 10,000

  22. Case Studies: Trading @ NAV

  23. Client Disadvantages – Further explanationNegative intraday price move

  24. Appendix

  25. How does one assess the liquidity of an ETP?

  26. ETPs. They trade like stocks..... ETF Securities Physical Gold (PHAU LN) and Barclays (BARC LN) have the same trading mechanics • On exchange • Europe:- approximately 7:50 am- 4:45 pm (UK Time:- includes auctions) • Intraday pricing via bid and offer prices • Order book size illustrates market makers buy/sell interest • OTC • Market Makers will offer two way prices • Normally (but not necessarily) larger size order • Normally (but not necessarily) higher commissions

  27. …but their liquidity has different drivers • Traditional Securities • Have a limited amount of free float shares available • Liquidity is driven by demand/supply • Historical volumes and trading patterns are used to predict future trading patterns • Exchange Traded Products • Price and liquidity are dictated by the underlying securities not the ETP • Extremely limited “supply/demand” effect as the funds are open ended • Historical volume is only useful to show popularity not tradability • Techniques like VWAP are irrelevant

  28. Primary & Secondary Market - Interconnected Investors trade via the exchanges (Secondary) or OTC directly with a market maker. The market maker will execute the order using existing inventory, via the exchanges or by creating/ redeeming units on the primary market. The decision on this will be based on the balance between what is cheapest and what bears least risk for the market maker. 1 2 3 ETP Existing Inventory Primary Market Market Makers Secondary Market Investors

  29. Underlying Liquidity

  30. ETP LiquidityLook at the underlying ETFS Wheat Ticker:- WEAT LN Average Daily Volume:- $1.54m CBOT Future Ticker:- W A Comdty Average Daily Volume:- $1,126m • Explanation • ETFS Wheat trades $1.54m per day on average • However, the relevant measure of how much trading can be done is the underlying contract • This trades over $2b per day on average - Ratio:- ETC/Future = 0.14% • Many times over $1.7m ADV could be traded through the ETC with minimal impact • Taking a conservative estimate of 10% of the average underlying trading, this means that $113m can be traded on the ETC without any significant price impact • UBS and BAML have committed to $250m each of liquidity per day for the products they back

  31. Arbitrageurs keep the price close to fair value • Trader sees the ETP trading at $25.70 vs the underlying at $25.50. She: • Buys underlying units at $25.50 • Sells ETP units at $25.70 • Creates ETP units in exchange for the underlyings i.e. at $25.50 • Risk free profit $0.20 per unit Fund: ETF Securities Example ETP Underlying ETP Mid Price: $25.00 Underlying Offer: $25.50 ETP Bid: $25.70

  32. Important Information • Important Information • General • This communication has been provided by ETF Securities (UK) Limited (“ETFS UK”) which is authorised and regulated by the United Kingdom Financial Services Authority. When being made within Italy, this communication is for the exclusive use of the “qualified investors” and its circulation among the public is prohibited. • This document is not, and under no circumstances is to be construed as, an advertisement or any other step in furtherance of a public offering of shares or securities in the United States or any province or territory thereof. Neither this document nor any copy hereof should be taken, transmitted or distributed (directly or indirectly) into the United States. • This document may contain independent market commentary prepared by ETFS UK based on publicly available information. ETFS UK does not warrant or guarantee the accuracy or correctness of any information contained herein and any opinions related to product or market activity may change. Any third party data providers used to source the information in this communication make no warranties or representation of any kind relating to such data. • The information contained in this communication is neither an offer for sale nor a solicitation of an offer to buy securities. This communication should not be used as the basis for any investment decision. • ETFS UK is required by the United Kingdom Financial Services Authority ("FSA") to clarify that it is not acting for you in any way in relation to the investment or investment activity to which this communication relates. In particular, ETFS UK will not provide any investment services to you and or advise you on the merits of, or make any recommendation to you in relation to, the terms of any transaction. No representative of ETFS UK is authorised to behave in any way which would lead you to believe otherwise. ETFS UK is not, therefore, responsible for providing you with the protections afforded to its clients and you should seek your own independent legal, investment and tax or other advice as you see fit.