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Transcript of For Professional Investors Only, Not For Public Dissemination Page 1.
For Professional Investors Only, Not For Public DisseminationPage 1
Implementing Investment Decisions with Exchange Traded Products
Netherlands CFA conference
21st November 2012
For Professional Investors Only, Not For Public DisseminationPage 3
Introduction Why is exchange traded product implementation important? Main methods of implementation Case Studies Optimisation Techniques
Table of Contents
Introduction
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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
Introduction and overview
Why is ETP implementation so important?
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Grumeti river Not possible to avoid
□ To get to the fertile plains
□ And to get back
The Great African Migration
Annual Event – Tanzania to Kenya 1,800 miles 1.5 m Wildebeest, 300k Zebra
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Asset allocation decision
Investment Decision Lifecycle
Product selection
Implementation
Initial Rebalance Exit
Total Cost Of Ownership
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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
Don’t Just Look At The Headline Fee
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Implementation is always important
However time horizons dictate the relative importance of implementation to the portfolio manager
The Importance of Time Horizons
Time Horizon Strategy Relative importance of implementation
Long Term Buy and Hold Low
Medium Term Regular rebalancing Medium
Short Term Tactical/Opportunistic High
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Example European ETPs – One Year Time Horizon
Provider 1
Provider 2
Provider 3
Provider 4
0 10 20 30 40 50
23
7
18
12
29
39
25
29
Total Cost (Bid-Offer Spred + 1 Year Total Expense Ratio)
Bid-Offer Spread 1 Yr TER
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Example European ETPs – One Month Time Horizon
Provider 1
Provider 2
Provider 3
Provider 4
0 5 10 15 20 25
23
18
12
7
2
2
2
3
Total Cost (Bid-Offer Spred + 1 Month Total Expense Ratio)
Bid-Offer Spread 1mth TER
Main Implementation Methods
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Main Methods for Implementation
On Exchange OTCRisk Risk @NAV
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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
Mid Price: - $25.00
Bid Price : - $24.50
Offer Price: - $25.50
Underlying spread
Risk spread
Creation spread
Existinginventory
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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
On Exchange OTC
Risk Risk @NAV
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Main Methods for Implementation: OTC @ Risk
On Exchange OTCRisk Risk @NAV
Advantages
Large blocks at one price
Direct recourse to market maker
Disadvantages
Counterparty risk
Credit Lines need to be in place
Not anonymous
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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
On Exchange OTC
Risk Risk @NAV
Main Methods for Implementation: OTC @ NAV
Optimising Portfolio Implemetation
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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
Suggestions for Optimising Portfolio Implementation
Case Studies: Trading On Exchange
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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
Trading ETPs on ExchangeExample: State Street Euro Corporate Bond (SYBC GY Equity)
Case Studies: Trading @ NAV
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Client Disadvantages – Further explanationNegative intraday price move
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Appendix
How does one assess the liquidity of an ETP?
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ETPs. They trade like stocks.....
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
ETF Securities Physical Gold (PHAU LN) and Barclays (BARC LN) have the same trading mechanics
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…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
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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.
Primary Market Secondary MarketMarket Makers
ExistingInventory
Investors
ETP
1
2
3
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Underlying Liquidity
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ETP LiquidityLook at the underlying
ETFS WheatTicker:- WEAT LNAverage Daily Volume:- $1.54m
CBOT FutureTicker:- W A ComdtyAverage 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 $250m each of liquidity per day for the products they back
ADV ($mn) Code ExchangeADV Month
Max DV Month
Min DV Prev Month
Wheat W CBOT 1,125.7 3,911.7 4.2
1st Month Futures**
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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
Mid Price: $25.00 Underlying Offer: $25.50 ETP Bid: $25.70
Underlying
ETP
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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.