Live ETF Trading Workshop: Achieving Best Executions When Trading ETFs Matt Hougan, Session Leader President of ETF Analytics, Global Head of Editorial IndexUniverse Ugo Egbunike, Session Leader ETF Analyst, IndexUniverse Cory Laing, Panelist Managing Director, Goldman Sachs Will McGough, CFA, Panelist Vice President, Portfolio Management, Stadion Money Management Thomas Smykowski, Panelist Head of Global Portfolio & ETF Execution, ConvergEx Group
Transcript
Live ETF Trading Workshop:
Achieving Best Executions
When Trading ETFs
Matt Hougan, Session Leader President of ETF Analytics, Global Head of Editorial IndexUniverse Ugo Egbunike, Session Leader ETF Analyst, IndexUniverse Cory Laing, Panelist Managing Director, Goldman Sachs Will McGough, CFA, Panelist Vice President, Portfolio Management, Stadion Money Management Thomas Smykowski, Panelist Head of Global Portfolio & ETF Execution, ConvergEx Group
Presenter
Presentation Notes
Hi, and welcome to the Live ETF Trading Workshop, always one of th funnest and most exciting sessions of our two-day conference.
Session Leaders
Matt Hougan President of ETF Analytics, Global Head of Editorial IndexUniverse
Ugo Egbunike ETF Analyst IndexUniverse
Presenter
Presentation Notes
I am Matt Hougan, and as most of you know by now, I am the President of ETF Analytics and Global Head of Editorial for IndexUniverse, and I’m pleased to be joined here on stage by my firend and colleague, one of the ETF analysts here at IndexUniverse. Ugo is a former ETF trader himself, having worked on a makret making desk, and he has forgotten more about trading than I will ever know.
Will McGough, CFA Vice President Portfolio Management Stadion Money Management
Thomas Smykowski Head of Global Portfolio & ETF Execution ConvergEx Group
Cory Laing Managing Director Goldman Sachs
Panelists
Presenter
Presentation Notes
Ugo and I have brought on three true experts to join us today: Cory Laing, managing director for Goldman Sachs on their ETF desk Will Mcgough, Vice Presidnet of Portfolio Managmenet for Stadion Money Management, which runs something like $6 billion in ETF portfolios. And Thomas Smykowski, head of global portfolio & ETF execution for the Convergyx Group, a leading market making desk. Also joining us today via phone, and with a window onto his computer Scren is INSERT NAME, live from Convergyx’s desk. And before the session is through, we’re going to put INSERT NAME through his paces giving us live quotes on a number of large ETF trades. Those of you who have been coming to this conference for a few years know that this is one of the panels where we kick back a little purpose of this panel is to help investors undrstand how to trade ETFs better; to show people tha thte liquidity they see on the screen in ETFs is not the liquidity in the ETF in general; and to remind peopleghow to trade ETFs
Part 1: The Basics In 5 Minutes
Sell at Bid, Buy at Ask
Bid/Ask Spread
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Presentation Notes
To understand why trading matters, let’s start at the beginning. The core thing to consider any time you are trading anything is the bid/ask spread. Just like a share of stock, an ETF share has two prices, one for buying and one for selling. If you’re buying ETF shares, you pay the Ask price. If you’re selling shares, you receive the Bid price. The difference between the two is the Bid/Ask spread. In this simple example, the spread in dollars is equal to $50.01 – $49.99, or 2 cents. To find the Bid-Ask spread as a percent – which is typically how it’s presented – you simply divide the dollar amount by the bid/ask midpoint of the fund. In this case, it’s two cents divided by $50, which equals 0.04%, or four basis points.
Sell at Bid, Buy at Ask
Bid/Ask Spread
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Presentation Notes
You’ll find that this number varies widely. This table shows the Bid/Ask Spread for 4 U.S. Financial sector funds, measured over a two month period at the tail end of last year. WE’ve presented the data here in both pennies per share and percent, because you see both quoted in the media. Pennies are a nice, intuitive way to consider spreads. But percents are more telling, as they account for the difference in share price. RWW’s 7 cent spread may look like it’s bigger than PFI’s 6 cent spread, but in fact RWW’s spread is tighter because of its higher share price. The same is true, actually, for IYF vs. XLF, despite the fact that XLF trades at the minimum possible spread of $0.01 per share. Needless to say, the tighter the spread, the lower the cost to trade the shares.
Bid/Ask Spread
Impact
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Presentation Notes
DAVE: Let’s take a moment to talk about the impact of these costs. It looks like a few pennies here or there, but the impact is quite significant. This chart adds the costs of the bid/ ask spread added to the expense ratio of each fund, assuming a 1 year holding period. Many investors and certainly many issuers focus on small differences in expense ratios. But as we can see here, trading costs like bid/ask spread need to be considered too. IYF and RWW have similar expense ratios, for instance, but once spread costs are considered, the cost are no longer equal. In the case of funds like RWW, the spreads can be more than half the expense ratio; sometime they are even more than that. The costs from the spread are paid when buying and selling the shares, so the proportional impact will be generally be greater for short term holdings and less for long term. Unlike expense ratios, which persist indefinitely, bid/ask spreads are only paid when you enter … and exit … the fund.
Bid/Ask Spread
Presenter
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Bid-Ask spreads can vary widely, not just from fund to fund, but over time. This chart shows bid ask spreads for 8 U.S. financial sector ETFs for 2010. Emerging Markets Small Cap
Market Order: Buy 1000 Shares
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MATT: The spread, however, is only part of the story. It’s important to realize that, if you put in a market order, you won’t necessarily get filled at the bid or ask. As noted before, different blocks of shares can be offered for sale in the market place at different prices. This stylized example gives a picture of how various blocks of shares can be offered for sale for a single ETF at different prices. Each block represents a set amount of shares. The prices are listed in the top row. In this example for fund ABC, a market order to buy 1000 shares gets completely filled at the inside Ask price of $50.01. This is a good outcome.
Market Order: Buy 1000 Shares
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The tradability of fund XYZ is quite different, however, even though they have the same top-line 2 cent bid/ask spread. Fewer market participants are willing to trade this fund at inside prices. Here, the 1000 share market order can’t be filled at the best price, so it’s filled at successively higher prices of $50.02, 50.03 & 50.04 etc. This is what happens when you enter a market order. It hits the top of the book, and then searches deeper and deeper to fill its share count. You “sweep the book” until you find the liquidity you are looking for. An investor can prevent this outcome by entering a limit order. A limit order to buy at say, $50.02, would prevent the purchase of shares above that price. The good news is that you avoid overpaying for the shares. The bad news is that, in this example, only 300 of the 1000 share order would be immediately filled. What happens to the other 700 shares is an open question. The “book” does and will refresh eventually; when the top order in the book is filled, market participants will react often to create a new “best bid”. This can take a few seconds to materialize, but if there are people willing to sell at that level, it will. In that case, by refusing to pay above $50.02, you might well find more liquidity there than you first imagined. On the other hand, for thinly traded funds, the balance of the order might expire unfilled, so you’d need to place limit order at a different price. How much can you save by entering a limit order at $50.02? The difference in purchase price with this simple example seems small: $18 on a $50,000 transaction, or about 4 basis points. But more costly real world examples happen every day. The key takeaway is that limit orders put a cap on the price to buy shares, or a floor under the price to sell. We encourage the use of limit orders especially for thinly traded funds. And critically, in the ETF space, there is often more liquidity in the market than is displayed publicly. Market participants don’t always want to give away the fact that they have a lot of shares to trade, so they don’t post that liquidity to the market. You may be able to put a limit order at or near the best bid or offer and “discover” liquidity that otherwise isn’t there.
iNAV = Indicative (or Intraday) Net Asset Value IOPV = Indication of Portfolio Value IV = Indicative Value (especially for ETNs)
Yardstick for the current Bid/Ask
The Beauty of iNAV
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Presentation Notes
So how can you as an investor know that you’re getting a fair price? Well, for one, you cannot rely on the actual fund NAV. Fund NAV’s – as reported by issuers – are struck once a day at 4pm. During the actual trading day, they convey no information about what the right price of the ETF should be. Securities Regulators, however, require all ETFs to publish an “iNAV,” which is a real-time estimate of the fund’s NAV published every 15 second of the trading day. DAVE TALKS ABOUT HOW TO GET THEM SPY HBTA AGG GXC
SPY vs. iNAV
$149.00
$149.50
$150.00
$150.50
$151.00
$151.50
30/01/2013 9:30 04/02/2013 16:00Last Price iNAV
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So how can you as an investor know that you’re getting a fair price? Well, for one, you cannot rely on the actual fund NAV. Fund NAV’s – as reported by issuers – are struck once a day at 4pm. During the actual trading day, they convey no information about what the right price of the ETF should be. Securities Regulators, however, require all ETFs to publish an “iNAV,” which is a real-time estimate of the fund’s NAV published every 15 second of the trading day. A Lot of ETFs trade like this.
Sometimes international markets over lap:
iNAV’s flaws in: International Funds
Bond Funds
Commodity Funds
and any other asynchronous things
…But not always:
The Crushing Horribleness of iNAV
Presenter
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DAVE: As we showed with GXC, the China fund, iNAV breaks for everything but domestic equities. The reason is simple: iNAV is priced based on the last traded price of the underlying securities. If those underlying securities happen to trade in, say, China, or Japan, the iNAV won’t update except to reflect changes in the currency rate. Something on London and part days. Something on China or Japan and full days.
Market Hours Overlap: GXC
$67.00
$67.50
$68.00
$68.50
$69.00
$69.50
$70.00
$70.50
1/18/12 8:00 AM 1/30/12 4:27 PM
GXC Price
GXC iNAV
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But then you see this same chart for something like GXC and it’s mind boggling. Why? Well that’s our next point.
Premiums/Discounts: EGPT
Protests begin January 25, 2011.
Egyptian Stock Exchange closes January 27, 2011
Mubarak resigns February 11, 2011.
Exchange reopens March 23, 2011.
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Then you have things like this where the market was closed and creations were suspended. The premiums went nuts, but corrected themselves quite quickly. The premium when the market reopened was right in line with where it was BEFORE the uprisings.
Trade
Elephants & Knotholes
Trade
Bulls & China Shops
What’s In An ETF Bid/Ask Spread?
Underlying NAV
Brokerage Fees
Market Maker P&L
Creation Costs
Forex Hedging Costs
Taxes
Bid Price
Ask Price
Market Maker P&L
Brokerage Fees
Taxes
Forex Hedging Costs
Redemption Fees
Underlying Bid/Ask
Spr
ead
ETF Spread
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Presentation Notes
This is a great slide we stole from SSgA for our Inside Trading conference. Your quotes are built, it’s not as simple as “I need a profit,” it’s also knowing what fees you’ll need to pay for taking that trade, and hedging the risk inherent in taking that position.
Price Discovery: Best vs. Available 2-Sided Quotes are fine, but WHEN do you want to
trade?
Immediately?
Layout the position over the next few hours?
Days? Weeks?
How is my strategy affecting my price?
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Presentation Notes
Which is why our focus today is this: execution strategy vs. price. What’s the best available price for the situation you’re in? The strategy underlying your trade is going to fundamentally change the prices you get. We’re going to switch over to some of our panelists to really get the advisor perspective on this.
Will McGough, CFA Vice President Portfolio Management Stadion Money Management
Every Basis Point Matters
Stadion’s Execution Beliefs Best Execution is Strategy not Price
Multiple Strategies per Vehicle and Outlook Integration of PM and Trading Pre/During/Post Trade Monitoring
Adapt Trading Practices to Ensure Same Avg. Net Price Leverage Technology for Downstream Automation Step-In Challenges (non-discretionary)
Know Your Counterparty Strengths and Weaknesses Risk is Risk Disclosure – Documentation and Reporting
The Keys to Trading ETFs Understand the fair value of the product you intend to trade.
Utilize the full arsenal of trade types when available.
Develop a relationship with your execution platform or
liquidity provider.
Do not undervalue the true cost of not paying attention to the execution of your ETF positions. Executing efficiently in the ETF markets is critical for the performance of your portfolios and can be easily achieved with a small amount of work. Source: Visual Guide to ETFs, David J. Abner. (173)
Generating Short Term Alpha
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Strategy EOD Strategy w/ Best Ex ST Alpha
Cory Laing Managing Director Goldman Sachs
GS ETF Desk Capabilities
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Let’s turn it over to Cory. Cory what’s the roll of the advisor in here.
Advisor Trends Impacting Trading Larger size Tougher tickers and more challenging parts of the
asset class spectrum More custodians and sub-advisory platforms
Order fragmentation
Greater reliance on risk and sell-side capital Advisors trade ‘at risk’ at a far greater rate than other institutions
Externalization of trading function Prohibitive step-out fees Historic under-resourcing on advisor trading desks
Role of High Touch Broker Dealers Trading is the most likely bottleneck to continued
growth if strategy doesn’t evolve Not updating your process often results in:
Performance Slippage
Adjusting your investment process/security selection often results in: Broken Business Model
Role of High Touch Broker Dealers Trading is the most likely bottleneck to continued
growth if strategy doesn’t evolve. So:
Either Change what you do: Modify investments Modify vehicles Swaps, notes, underlying portfolios, etc….
Or Change how you do it Trading
There is no magic ‘best practice’ once size is achieved. Do the work, use the sell-side for more than just price and know your alternatives
Do the work, use the sell-side for more than just price and know your alternatives
Trading performance is determined far more by execution strategy than by sourcing prices
Role of High Touch Broker Dealers
Role of High Touch Broker Dealers Dealers have massive infrastructures set-up to
provide execution advice: Pre-trade analytics Run scenarios on trading alternatives when transacting Granular breakdown of cost components:
Transaction Cost Analysis (TCA) to help understand trading Alpha and behavioral patterns
Role of High Touch Broker Dealers It is to your benefit to have dealer relationships
who understands your entire business Know how to:
Minimize order fragmentation Achieve client equitability issues Achieve & document best execution responsibilities
How to control information leakage: Formal leakage Detectable trading patterns that have the same effect
Cash Management How to keep you properly invested through a rebalance
Pre-trade “strike” price
For example, mid-quote at order arrival
Execution price
Volume-weighted average if multiple executions
Post-trade price
Mid-quote 5 minutes after last execution?
Same day close?
T+1 to T+5 average?
Execution Quality Analysis
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Execution price
Same-day closing price
Execution shortfall
ST-alpha capture
Short-term (ST) alpha
Price T+1 to T+5
1
2
3 Mid-quote 5-mins post
execution
After trade impact has subsided What is my trading cost?
What is my short-term alpha? What is my cost relative to my short-term alpha?
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therefore realize each day a loss or a gain which is a multiple (for leveraged ETFs and ETNs) or the inverse (for inverse ETFs and ETNs) of the performance on that day of their underlying index or benchmark. For this reason, if they are held for a period longer than one day, their performance over such longer periods of time can differ significantly from the stated multiple of the performance (or the inverse of the performance) of their underlying index or benchmark during the same period of time. This effect can be magnified in volatile markets. Prior to entering into a transaction in leveraged or inverse ETFs, you should be aware of the general risks associated with such transactions. You should not enter into leveraged or inverse ETFs transactions unless you understand the nature and extent of your risk exposure. You should also be satisfied that the leveraged or inverse ETFs transaction is appropriate for you in light of your circumstances and financial condition.
ETFs and ETNs that are linked to commodity futures do not offer direct exposure to the commodity’s spot price, and may perform differently than the
spot price for the commodity itself. Performance differential can be magnified if a specific condition persists in the market for a commodity that creates a disparity between near-term future prices and long-term future prices and may lead to unexpected performance results. Other factors, such as roll yield, transaction costs, management fees, and taxes may cause deviation in performance between the spot price of a commodity and commodity futures. You should not assume that an ETF or ETN that is linked to commodity futures will provide an effective hedge because of a negative correlation with equities or other asset classes. You should always be aware of the general risks associated with investing in the commodities market and the futures market before investing in an ETF or ETN that is linked to commodity futures.
Thomas Smykowski Head of Global Portfolio & ETF Execution ConvergEx Group
ConvergEx ETF Execution
Algorithmic Strategies Trade Size Liquidity Analysis Historical Spread and Volatility Average Volume Profile
Block Execution Estimating Fair Value
Underlying Securities Creations/Redemption Fees Brokerage Cost (Commissions and Taxes) Slippage Risk (Hedging Costs) ETF Inventory Alternative Hedging Vehicles
Primary Market Versus Secondary Market Examples:
Side Ticker Fund ETY Type Shares Approx. Value
BUY SDOG ALPS Sector Dividend Dogs ETF US Equity 1,700,000 48,035,200$ SELL FVD First Trust Value Line Dividend Index Fund US Equity 2,700,000 49,237,200$
Side Ticker Fund ETY Type Shares Approx. ValueBUY/SELL VWO Vanguard FTSE Emerging Markets ETF International Equity 1,100,000 48,240,500$ BUY/SELL EEM iShares MSCI Emerging Markets Index Fund International Equity 1,100,000 47,762,000$
ETF Rebalances Pre-Trade Analysis
(Opportunity Cost versus Market Impact)
Correlation and Exposure Trade Horizon
Side Ticker Fund ETY Type Shares Approx. ValueBUY PWV PowerShares Dynamic Large Cap Value Portfolio US Equity 430478 10,000,004$ BUY FDN First Trust Dow Jones Internet Index Fund US Equity 237478 9,999,985$ BUY FXH First Trust Health Care AlphaDEX Fund US Equity 279630 9,999,988$ BUY EWG iShares MSCI Germany Index Fund International Equity 402901 10,000,003$ BUY MOO Market Vectors Agribusiness ETF International Equity 181159 9,999,977$ SELL VTI Vanguard Total Stock Market ETF US Equity 77369 5,999,966$ SELL IYE iShares Dow Jones US Energy Sector Index Fund US Equity 135624 6,000,006$ SELL IYF iShares Dow Jones US Financial Sector Index Fund US Equity 92282 5,999,991$ SELL BIL SPDR Barclays 1-3 Month T-Bill Fixed Income 130989 6,000,017$ SELL STPZ PIMCO 1-5 Year U.S. TIPS Index Exchange-Traded Fund Fixed Income 110640 6,000,007$ SELL PLW PowerShares 1-30 Laddered Treasury Portfolio Fixed Income 187207 5,999,984$ SELL HYG iShares iBoxx $ High Yield Corporate Bond Fund Fixed Income 64586 6,000,039$ SELL EWJ iShares MSCI Japan Index Fund International Equity 798005 8,000,000$
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In the interest of showing you just what we’re talking about in terms of strategy we’ve asked Cory and Will to go under the hood as it were and give us the pre-trade quantitative analysis that they run that build the prices you get when you make that call. Now we know that these aren’t live trades, but we’ll get back to that with Tom afterwards. (X) shares of (Ticker) Walk through the kind of pre-trade analysis an advisor could/should do Show what a “risk price” would be Discuss other ways of working the trade, how to evaluate success Alternate ways of getting similar exposure
Cory Laing Managing Director Goldman Sachs
Building ETF Prices
Breaking Down ETF Prices Behavioral factors
Trade ‘packaging’ Order fragmentation Follow-on flow Information leakage
Competitive bidding Predictability
Economic factors (Costs and Risk) Liquidity Volatility Tracking error of available hedges Stamp taxes, creation fees & hard friction costs Balance sheet and cost of capital Creation mechanism Underlying market norms and idiosyncrasies
ETF prices are determined by 2 main factors:
The question too many people fail to ask is…
Do you actually want to pay
for all of this?
Pre-Trade Portfolio Summary Trade Date: January: 30, 2013. For illustrative purposes only
For illustrative purposes only
Pre-Trade Portfolio Summary Trade Date: January: 30, 2013. For illustrative purposes only
For illustrative purposes only
Case Study For a Buy of XHB Correlated Assets
Hedge Optimizer
54% RTA1 46%XLY
9bps daily risk
6bps est. T-Cost
Source: Goldman Sachs Securities Division, Bloomberg. As of 1/31/13
Case Study For a Buy of XHB Risk pricing and components:
Liquidity: 4cps (14.5bps)
Hedge: 1cps (3bps)
Risk: 2.5cps (10bps)
Friction: 0cps (0bps)
Counterparty ?
As of 1/31/13
Pre-Trade Portfolio Summary Trade Date: January: 30, 2013. For illustrative purposes only
Pre-Trade Portfolio Summary Trade Date: January: 30, 2013. For illustrative purposes only
Case Study for EPP: Relativity Premium on EPP at 1:14PM: 0.11%
Source: Goldman Sachs Securities Division, Bloomberg. As of 1/31/13
Case Study for EPP - Risk Exposures
Source: Goldman Sachs Securities Division, Bloomberg. As of 1/31/13
Case Study for Sale of EPP Risk pricing and components:
Liquidity: 5.5cps (11.5bps)
Hedge: -1.5cps (-3bps)
Risk: 5cps (10bps)
Friction: 0cps (0bps)***
Counterparty ?
As of 1/31/13
Case Study for Sale of BND Source: Goldman Sachs Securities Division, Bloomberg. As of 1/31/13
Sample Transaction Costs:
Case Study for Sale of BND
As of 1/31/13
Case Study for Sale of BND Risk pricing and components:
Pricing relative to NAV
ETF Liquidity: +3cps (+4bps)
Bond Liquidity: -9.5cps (-11.6bps)
OR
Risk: -3cps (10bps)
Friction (if redeemed): 1cps (1bps)
Counterparty ? As of 1/31/13
IOO vs. EEM Source: Goldman Sachs Securities Division, Bloomberg. As of 1/31/13
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ETFs and ETNs that are linked to commodity futures do not offer direct exposure to the commodity’s spot price, and may perform differently than the
spot price for the commodity itself. Performance differential can be magnified if a specific condition persists in the market for a commodity that creates a disparity between near-term future prices and long-term future prices and may lead to unexpected performance results. Other factors, such as roll yield, transaction costs, management fees, and taxes may cause deviation in performance between the spot price of a commodity and commodity futures. You should not assume that an ETF or ETN that is linked to commodity futures will provide an effective hedge because of a negative correlation with equities or other asset classes. You should always be aware of the general risks associated with investing in the commodities market and the futures market before investing in an ETF or ETN that is linked to commodity futures.
Will McGough, CFA Vice President Portfolio Management Stadion Money Management
Pair Trading & Execution Strategy
Pair Trade - Sell 1M EEM to buy 700k IOO
.93 @ .94 Trades .93
.90 @ .02 Trades .965
.95 @ .07 Trades .02
VWAP Avg Pr .97
Pair Trade - Selling 8mm EWJ to 2mm DXJ
… about 50% crosses, 13 bps tracking daily, spreads in the stocks are a bit wide, but adv is only about 2.5%, so very liquid on both sides…
DXJ -- Dec 13, 2012
DXJ -- Last 5 Trading Days
Traded 10% on risk @ .62
Traded 5% on risk @ .97,.15
Average Price = 55.8357 5,104,034 Shares No Impact, didn’t trade on Secondary Combination Basket/Futures/2ndary Strategy Beat VWAP of Day, VWAP during Window and Close
Multiple Leg Strategy
Worked 20% from 10-11 ~55.76avg
Worked 40% from 11-12 ~55.77avg
Worked 20% from 12-130
~56.013avg
Trading Covers All Situations Small Lots (<10k) – Algo Destinations
Small Blocks (10k-50k) – Agency Liq Agg, Prop/Bal Sheet Providers
Mega Blocks (1mm++) – Negotiated 5mm XLI, 4mm IEFA
Part 4: Live Trading
Presenter
Presentation Notes
So this brings us to our actual live portion of the session, we’ve got Troy Donehue on the line from Convergex, and we’re going to walk through in real time how they build a quote and price out risk for you. Meat: Scenarios (30 minutes) Go to the agency screen from Convergex Repeat for US Equity, Intl. Equity, Fixed income, Commodities: (X) shares of (Ticker) Walk through the kind of pre-trade analysis an advisor could/should do Show what a “risk price” would be Discuss other ways of working the trade, how to evaluate success Alternate ways of getting similar exposure
Thank You. Questions?
Live ETF Trading Workshop:
Achieving Best Executions
When Trading ETFs
Matt Hougan, Session Leader President of ETF Analytics, Global Head of Editorial IndexUniverse Ugo Egbunike, Session Leader ETF Analyst, IndexUniverse Cory Laing, Panelist Managing Director, Goldman Sachs Will McGough, CFA, Panelist Vice President, Portfolio Management, Stadion Money Management Thomas Smykowski, Panelist Head of Global Portfolio & ETF Execution, ConvergEx Group
