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For Professional Investors Only, Not For Public Dissemination
Implementing Investment Decisions with
Exchange Traded Products
Netherlands CFA conference
21st November 2012
Table of Contents
 Introduction
 Why is exchange traded product implementation important?
 Main methods of implementation
 Case Studies
 Optimisation Techniques
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Introduction
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
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Why is ETP implementation so important?
The Great African Migration
 Annual Event – Tanzania to Kenya
 1,800 miles
 1.5 m Wildebeest, 300k Zebra


Grumeti river
Not possible to avoid
□
□
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To get to the fertile plains
And to get back
Investment Decision Lifecycle
Asset allocation decision
Product selection
Implementation
Initial
Rebalance
Total Cost Of Ownership
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Exit
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
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The Importance of Time Horizons


Implementation is always important
However time horizons dictate the relative importance of implementation to the
portfolio manager
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
Total Cost (Bid-Offer Spred + 1 Year Total Expense Ratio)
12
Provider 4
29
18
Provider 3
25
7
Provider 2
39
23
Provider 1
0
10
29
20
Bid-Offer Spread
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30
40
1 Yr TER
50
Example European ETPs – One Month Time Horizon
Total Cost (Bid-Offer Spred + 1 Month Total Expense Ratio)
7
Provider 4
3
12
Provider 3
2
18
Provider 2
2
23
Provider 1
0
5
10
Bid-Offer Spread
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2
15
1mth TER
20
25
Main Implementation Methods
Main Methods for Implementation
On Exchange
Risk
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OTC
Risk
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@NAV
ETPs are priced with reference to their underlying
However 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
Mid Price: - $25.00
Underlying spread
Bid Price : - $24.50
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Main Methods for Implementation: On Exchange
On Exchange
Risk
OTC
Risk
Advantages
Disadvantages
 Anonymous
 Orderbooks can be shallow
 Centrally cleared
 No direct recourse to market
maker
 Usually cheap
 Usually multiple counterparties
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@NAV
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Main Methods for Implementation: OTC @ Risk
On Exchange
Risk
OTC
Risk
Advantages
@NAV
Disadvantages
 Large blocks at one price
 Counterparty risk
 Direct recourse to market maker
 Credit Lines need to be in place
 Not anonymous
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Main Methods for Implementation: OTC @ NAV
On Exchange
Risk
OTC
Risk
Advantages
 No market risk
Market Maker
Client
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@NAV
Disadvantages
 No opportunity to price at risk
 Paid commissions for little work
 Achieve NAV
 Negative intraday price move
 Lower cost than a risk trade
(usually)
 No possibility to “get inside spread
of underlying”
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Optimising Portfolio Implemetation
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
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Case Studies: Trading On Exchange
Trading ETPs on Exchange
Example: 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:





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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
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Case Studies: Trading @ NAV
Client Disadvantages – Further explanation
Negative intraday price move
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Appendix
How does one assess the liquidity of an ETP?
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
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ETF Securities Physical Gold (PHAU LN) and Barclays
(BARC LN) have the same trading mechanics
…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
1
Investors trade via the exchanges (Secondary) or OTC directly with a market maker.
2
The market maker will execute the order using existing inventory, via the exchanges or
by creating/ redeeming units on the primary market.
3
The decision on this will be based on the balance between what is cheapest and what
bears least risk for the market maker.
ETP
Existing
Inventory
Primary Market
Market Makers
Secondary Market
Investors
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Underlying Liquidity
ETP Liquidity
Look at the underlying
ETFS Wheat
Ticker:- WEAT LN
Average Daily Volume:- $1.54m
CBOT Future
Ticker:- W A Comdty
Average Daily Volume:- $1,126m
ADV ($mn)
Wheat
Code
W
Exchange
CBOT
1st Month Futures**
Max DV
Min DV Prev
ADV Month
Month
Month
1,125.7
3,911.7
4.2
Explanation






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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
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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
Underlying
ETP
Mid Price: $25.00
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Underlying Offer: $25.50
For Professional Investors Only, Not For Public Dissemination
ETP Bid: $25.70
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
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
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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.

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
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
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