Generating Excess Returns When Executing ETF Trades

Transcription

1 Generating Excess Returns When Executing ETF Trades Ugo Egbunike, Moderator Director of Business Development ETF.com Sanjay Chablaney, Panelist Head of ETF Trading Bank of America Merrill Lunch Tim Coyne, Panelist Global Head of SPDR, ETF Capital Markets State Street Global Advisors Robert Glownia, CFA, Panelist Quantitative Analyst RiverFront Investments Group LLC

2 Sanjay Chablaney Panelist Head of ETF Trading Bank of America Merrill Lunch Ugo Egbunike Moderator Director of Business Development ETF.com Tim Coyne Panelist Global Head of SPDR ETF Capital Markets State Street Global Advisors Robert Glownia, CFA Panelist Quantitative Analyst RiverFront Investments Group LLC

3 Working with APs and Liquidity Providers Sanjay Chablaney Panelist Head of ETF Trading Bank of America Merrill Lunch

4 Mechanics of ETFs Open-ended structure allows market makers to "create" or "redeem" shares of the ETF in exchange for cash or the underlying securities held by the fund. A full-service franchise like Bank of America Merrill Lynch is an Authorized Participant (i.e. can transact directly with the fund) for virtually all ETFs and can do this whether the underlings are equities, bonds, currencies, MLPs or commodities. Equity Creation Work Flow Investor sends cash to Authorized Participant A.P. delivers underlyings to Fund Manager Investors Buys 50,000 ETF Shares Authorized Participant (BAML) ETF Fund Manager A.P. delivers ETF shares to Investor Fund Manager provides ETF shares to A.P. Example of Basket Liquidity: The below examples are ETFs that Bank of America Merrill Lynch can create liquidity through trading the underlying basket. Agency Markets vs. Risk Markets: Pros / Cons of each, Uses, Liquidity advantages Source: Bloomberg, Bank of America Merrill Lynch as of 11/12/13

5 Mechanics of ETFs Fixed Income ETF Liquidity Many Fixed Income ETFs contain hundreds of bonds which makes buying a full replication of the ETF extremely difficult. ETF issuers have created a process whereby the Authorized Participants like Bank of America Merrill Lynch can deliver a smaller subset of bonds to facilitate creation of an ETF. This subset creation basket is published daily and contains a limited number of bonds which can be delivered in exchange for an ETF share. In this way, the liquidity of fixed income ETFs is derived from the larger pool of liquidity in the underlying bonds. HYG Example: HYG AUM is $16 billion The ETF Fund Manager Publishes Creation and Redemption baskets daily approximately 40 names The ETF tracks the iboxx Liquid High Yield Index Authorized Participant (BAML) ETF Fund Manager The ETF currently holds approx 700 different issues The AP delivers creation basket to receive shares and receives redemption basket after delivering shares Example of Screen Liquidity: In addition to creation liquidity, several fixed income ETFs have very good on screen liquidity and have become "trading vehicles. Source: Bloomberg, Bank of America Merrill Lynch as of 11/12/13

6 Mechanics of ETFs International Equity ETFs One of the fastest growing areas has been the growth of International Equity ETFs. Over 29 billion in new assets were added to Emerging Market ETFs in 2012, an increase in 26%. Bank of America Merrill Lynch is a leader in the International ETF creations because we trade locally in almost all of the underlying markets across the globe. EEM Example: Europe Desk EEM AUM is $44 billion and growing Asia Desk LatAm Desk The ETF tracks the performance of the MSCI Emerging Market Index Mexico The ETF currently holds 792 equity names that trade in 19 countries. (8 Asia, 7 Eastern Europe, 4 Latin America.) New Zealand Authorized Participant (BAML) South America Indicative Markets on International ETFs: Source: Bloomberg, Bank of America Merrill Lynch as of 11/12/13

7 Premiums/ Discounts of ETFs International Equity ETFs (PODS) Premium or Discounts Ticker NAME PX LAST INAV ticker INAV Prem/Disc NAV ticker Fund NAV Prem/Disc FUND_COMP_NAME GXC SPDR S&P CHINA ETF $74.60 GXCIV $ % GXCNV $ % State Street ETF/USA FEZ SPDR EURO STOXX 50 ETF $41.00 FEZIV $ % FEZNV $ % State Street ETF/USA EWG ISHARES MSCI GERMANY ETF $30.82 EWGIV $ % EWGNV $ % ishares/usa EFA ISHARES MSCI EAFE ETF $65.95 EFAIV $ % EFANV $ % ishares/usa EEM ISHARES MSCI EMERGING MARKET $39.80 EEMIV $ % EEMNV $ % ishares/usa GMM SPDR S&P EMG MARKETS ETF $62.03 GMMIV $ % GMMNV $ % State Street ETF/USA BIK SPDR S&P BRIC 40 ETF $22.66 BIKIV $ % BIKNV $ % State Street ETF/USA EWJ ISHARES MSCI JAPAN ETF $11.92 EWJIV $ % EWJNV $ % ishares/usa DXJ WISDOMTREE JAPAN HEDGED EQ $49.35 DXJIV $ % DXJNV $ % WisdomTree ETFs/USA VGK VANGUARD FTSE EUROPE ETF $57.73 VWOIV $ % VGKNV $ % Vanguard ETF/USA EPI WISDOMTREE INDIA EARNINGS $16.76 EPIIV $ % EPINV $ % WisdomTree ETFs/USA RBL SPDR S&P RUSSIA ETF $26.54 RBLIV $ % RBLNV $ % State Street ETF/USA NAV (Net Asset Value) - The NAV is the dollar value of one unit of an exchange traded fund. It's calculated by totaling the value of all the fund's holdings plus money awaiting investment, subtracting operating expenses, and dividing by the number of outstanding shares. inav (Indicative Net Asset Value) - Indicative Net Asset Value or inav or simply indicative value is the measure of net asset value of a fund or instrument according to the change in price of underlying instrument. For international ETFs with underliers that are closed or partially closed inav can imply moves in FX and/or interest rates. Source: Bloomberg, Bank of America Merrill Lynch as of 11/12/13

8 ETF Algo Trading Advanced Execution Solution: Instinct ETF The Instinct ETF algorithm utilizes tools previously available only to sophisticated sell side trading desks. Our proprietary algorithm performs real-time analysis of market depth and pricing across all US ETF related sources of liquidity. The Instinct ETF algorithm engine optimizes executions against the ETF, its underlying constituents, and futures. Our high-speed, multi-asset routing capability then quickly and efficiently accesses liquidity across multiple trading venues. Based on the fills in the ETF; its underlying constituents and futures, the Instinct ETF algorithm engine calculates the corresponding price in the ETF itself and delivers the ETF back to you. How Instinct ETF Works ETF Order sent to the Instinct ETF Algo Instinct ETF engine performs real-time analysis of market depth and pricing for multiple assets Orders directed to appropriate venues as per optimized asset mix Instinct ETF calculates corresponding ETF price ETF fills are returned to client More Shares Are Executed Futures Market Data ETF Market Data Constituent Market Data ETF Order 1 2 Instinct ETF Engine 4 Futures Markets Multi-Asset Router 3 ETF Fills 5 Equity Markets Instinct ETF Features Improve liquidity while reducing price impact Extended trading hours supported Support for all ETF's Real-time fill reporting Configurable criteria checks Order amendment supported Available via multiple 3 rd party OMS/EMS providers and at a Better Price

9 Changing Landscape of ETF Trading 24 Hour ETF Trading Bank of America Merrill Lynch makes markets in over 25 US listed ETF during Asian and European hours. Every trading day Bank of America Merrill Lynch clients adjust their US ETF exposure by transacting in US listed ETFs during non US trading hours. We have a 24 hour toll free number MER-4-ETF ( ) that follows the trading day and is manned from the US to Asia and then Europe. Booking The agreement on price and quantity occurs when the US reporting facilities are closed Bank of America Merrill Lynch reports the trade when the US reporting facilities open at 8 AM EDT Booking, settlement and commissions are identical to normal US trades Liquidity Greater liquidity available in Asian and European exposed products when the respective markets are open Borrow is deeper and more readily available during local market hours Pricing Greater pricing transparency for Asian and Euro exposed ETFs as underlying names are open and trading Indicative sizes in select names across regions for 24-hour trading:

10 International Pricing Global Portfolio Trading: Liquidity Through Creations and Redemptions Through Bank of America Merrill Lynch's global portfolio trading capabilities clients can choose to trade the underlying ETF constituents in the primary market rather than the ETF. Depending on the circumstances, a creation or redemption order whereby the ETF constituents are traded may offer better liquidity and pricing. In other words, creating/redeeming an ETF serves as an additional source of liquidity. SCJ Example: ishares MSCI Japan Small-Cap ETF (SCJ) tracks the MSCI Small Cap Japan Index. The ETF currently holds roughly 740 securities. Current AUM = $130MM Client came to Bank of America Merrill Lynch and wanted to purchase what would equate to 10% of the AUM of SCJ; however the ETF was not liquid enough in the U.S. Through the Bank of America Merrill Lynch Global PT desk, we were able to trade the underlying locally in Japan, create the shares in the US, and deliver to the client without significant market impact Asset Manager purchased $20 million notional of the ETF through Bank of America Merrill Lynch's Global Portfolio desk. Bank of America Merrill Lynch creates and delivers the ETF to the client. Small Cap Basket ETF Experience Creation Team: Bank of America Merrill Lynch is one of the leading APs for creations, particularly in international and emerging market ETFs. We actively create and redeem across all the issuers. We have notable market share in the following ETFs: Source: Bloomberg, Bank of America Merrill Lynch as of 11/12/13

11 Disclaimer (1) In certain regions or jurisdictions this disclaimer may not apply. You must consult with your regional Origination Counsel to ascertain whether this disclaimer is applicable. "Bank of America Merrill Lynch" is the marketing name for the global banking and global markets businesses of Bank of America Corporation. Lending, derivatives, and other commercial banking activities are performed globally by banking affiliates of Bank of America Corporation, including Bank of America, N.A., member FDIC. Securities, strategic advisory, and other investment banking activities are performed globally by investment banking affiliates of Bank of America Corporation ("Investment Banking Affiliates"), including, in the United States, Merrill Lynch, Pierce, Fenner & Smith Incorporated and Merrill Lynch Professional Clearing Corp., which are both registered broker dealers and members of FINRA and SIPC, and, in other jurisdictions, by locally registered entities. Investment products offered by Investment Banking Affiliates: Are Not FDIC Insured * May Lose Value * Are Not Bank Guaranteed. These materials have been prepared by one or more subsidiaries of Bank of America Corporation for the client or potential client to whom such materials are directly addressed and delivered (the "Company") in connection with an actual or potential mandate or engagement and may not be used or relied upon for any purpose other than as specifically contemplated by a written agreement with us. These materials are based on information provided by or on behalf of the Company and/or other potential transaction participants, from public sources or otherwise reviewed by us. We assume no responsibility for independent investigation or verification of such information (including, without limitation, data from third party suppliers) and have relied on such information being complete and accurate in all material respects. To the extent such information includes estimates and forecasts of future financial performance prepared by or reviewed with the managements of the Company and/or other potential transaction participants or obtained from public sources, we have assumed that such estimates and forecasts have been reasonably prepared on bases reflecting the best currently available estimates and judgments of such managements (or, with respect to estimates and forecasts obtained from public sources, represent reasonable estimates). No representation or warranty, express or implied, is made as to the accuracy or completeness of such information and nothing contained herein is, or shall be relied upon as, a representation, whether as to the past, the present or the future. These materials were designed for use by specific persons familiar with the business and affairs of the Company and are being furnished and should be considered only in connection with other information, oral or written, being provided by us in connection herewith. These materials are not intended to provide the sole basis for evaluating, and should not be considered a recommendation with respect to, any transaction or other matter. These materials do not constitute an offer or solicitation to sell or purchase any securities and are not a commitment by Bank of America Corporation or any of its affiliates to provide or arrange any financing for any transaction or to purchase any security in connection therewith. These materials are for discussion purposes only and are subject to our review and assessment from a legal, compliance, accounting policy and risk perspective, as appropriate, following our discussion with the Company. We assume no obligation to update or otherwise revise these materials. These materials have not been prepared with a view toward public disclosure under applicable securities laws or otherwise, are intended for the benefit and use of the Company, and may not be reproduced, disseminated, quoted or referred to, in whole or in part, without our prior written consent. These materials may not reflect information known to other professionals in other business areas of Bank of America Corporation and its affiliates.

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13 Working with ETF Capital Markets Desks Tim Coyne Panelist Global Head of SPDR ETF Capital Markets State Street Global Advisors

14 3 Pillars of Client Support

15 The Liquidity Ecosystem

16 PricingInsight Recent Block Trade Analysis: Understanding the characteristics of similar trades in different market conditions Live Secondary Market Analytics Spread/Volume Premium/Discount Institutional Pre-Trade Tools Underlying impact Execution Range Estimation

17 SPDR Capital Markets Group Client put $550mm to work in Short Term Corporates (SCPB) needed to transact at one price point Worked with Capital Markets and an AP to discuss impact, methods of execution, etc Purchased 25x the 1 month ADV in one day with little impact on the fund and their entry point SCPB 3 month Premium/Discount Screenshot w/ Volume** June 25, 2013 Volume 19,775,996 Volume ($) $606,233,157 Prev 1 mo. ADV 723,923 Prev 1 mo. $ ADV $22,222,704 Spread ($) $0.01 Spread (bps) 0.03% Basket Spread 0.38% Daily Volatility 0.10% NAV Price Calc Evaluated Bid

18 Disclosures (1) FOR INVESTMENT PROFESSIONAL USE ONLY. Not for use with the public. Important Risk Information: ETFs trade like stocks, are subject to investment risk, fluctuate in market value and may trade at prices above or below the ETFs net asset value. Brokerage commissions and ETF expenses will reduce returns. While the shares of ETFs are tradable on secondary markets, they may not readily trade in all market conditions and may trade at significant discounts in periods of market stress. Frequent trading of ETFs could significantly increase commissions and other costs such that they may offset any savings from low fees or costs. Diversification does not ensure a profit or guarantee against loss. Past performance is no guarantee of future results. There can be no assurance that a liquid market will be maintained for ETF shares.

19 Disclosures (2) The views expressed are the current views of the State Street Global Advisors Intermediary Business Group through the period of December 17, 2012 only and are subject to change based on market and other conditions. These views should not be relied upon as investment advice, as securities recommendations, or as an indication of trading intent on behalf of any State Street investment product. It does not take into account any investor s particular investment objectives, strategies, tax status or investment horizon. We encourage you to consult your tax or financial advisor. Individual securities mentioned are for illustrative purposes only and may not be relied upon as investment advice or as an indication of trading intent on behalf of any State Street product. All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. The trademarks and service marks referenced herein are the property of their respective owners. Third party data providers make no warranties or representations of any kind relating to the accuracy, completeness or timeliness of the data and have no liability for damages of any kind relating to the use of such data. SPDR is a registered trademark of Standard & Poor Financial Services LLC ("S&P") and has been licensed for use by State Street Corporation. No financial product offered by State Street Corporation or its affiliates is sponsored, endorsed, sold or promoted by S&P or its Affiliates, and S&P and its affiliates make no representation, warranty or condition regarding the advisability of buying, selling or holding units/shares in such products. This material or any portion thereof may not be reprinted or redistributed without the written consent of SSgA. Published by: State Street Global Advisors, State Street Financial Center, One Lincoln Street, Boston, MA Important disclosures continued on next page

20 Disclosures (3) Risk associated with equity investing include stock values which may fluctuate in response to the activities of individual companies and general market and economic conditions. Because of their narrow focus, sector investing tends to be more volatile than investments that diversify across many sectors and companies. Investing in high yield fixed income securities, otherwise known as unk bonds is considered speculative and involves greater risk of loss of principal and interest than investing in investment grade fixed income securities. These Lower-quality debt securities involve greater risk of default or price changes due to potential changes in the credit quality of the issuer. Foreign investments involve greater risks than US investments, including political and economic risks and the risk of currency fluctuations, all of which may be magnified in emerging markets. Bond funds contain interest rate risk (as interest rates rise bond prices usually fall); the risk of issuer default; issuer credit risk; liquidity risk; and inflation risk. Investments in small-sized companies may involve greater risks than in those of larger, better known companies. Investments in asset backed and mortgage backed securities are subject to prepayment risk which can limit the potential for gain during a declining interest rate environment and increases the potential for loss in a rising interest rate environment. Actively managed ETFs do not seek to replicate the performance of a specified index. Non-diversified funds that focus on a relatively small number of [stocks, issuers, countries] tend to be more volatile than diversified funds and the market as a whole. The Fund invests by sampling the index, holding a range of securities that, in the aggregate, approximates the full Index in terms of key risk factors and other characteristics which may cause the Fund to experience tracking errors relative to performance of the index.

21 Disclosures (4) SSgA Funds is a service mark of State Street Corporation. Distributor: State Street Global Markets, LLC, member FINRA, SIPC, a wholly owned subsidiary of State Street Corporation. References to State Street may include State Street Corporation and its affiliates. Certain State Street affiliates provide services and receive fees from the SPDR ETFs. ALPS Distributors, Inc., a registered broker-dealer, is distributor for SPDR shares, MidCap SPDRs and Dow Jones Industrial Average, all unit investment trusts and Select Sector SPDRs. Before investing in any SPDR ETFs, consider the funds investment objectives, risks, charges and expenses. To obtain a prospectus or summary prospectus which contains this and other information, call or visit Read it carefully. IBG-7571

22 ETF Trading: The Buy-Side Perspective Robert Glownia, CFA Panelist Quantitative Analyst RiverFront Investments Group LLC

23 Understanding ETF Liquidity Access to a larger investable universe Asset classes where it was previously hard to invest Master Limited Partnerships (MLPs), Micro Caps, High or Low Volatility, etc. Trading affects Portfolio Performance!! Implementation vs. Research

24 Trading Methods Trade in the secondary market Trade in high-touch risk market Trade the basket of securities that make up the ETF Use some combination of the methods above

25 Trade ETF in the Secondary Market ETFs trade on an exchange, but are NOT stocks Average Daily Volume Algorithms

26 High-Touch Risk Markets Urgency Typically pay a premium to unload risk Who to call? How many desks?

27 Trade the ETF Basket Helpful when ETF spread is wider than what is justified by the underlying liquidity profile Typically more passive Creation / Redemption Process

28 State of the Market ETF market making has become VERY competitive Transparency should be expected Resources available Capital Markets Teams

29 Disclosures MLP investing includes risks such as equity- and commodity-like volatility. Also, distribution payouts sometimes include the return of principal and, in these instances, references to these payouts as "dividends" or "yields" may be inaccurate and may overstate the profitability/success of the MLP. Additionally, there are potentially complex and adverse tax consequences associated with investing in MLPs. This is largely dependent on how the MLPs are structured and the vehicle used to invest in the MLPs. It is strongly recommended that an investor consider and understand these characteristics of MLPs and consult with a financial and tax professional prior to investment. Micro-cap companies may be hindered as a result of limited resources or less diverse products or services and have therefore historically been more volatile than the stocks of larger, more established companies. RiverFront Investment Group, LLC, is an investment advisor registered with the Securities Exchange Commission under the Investment Advisors Act of The company manages a variety of portfolios utilizing stocks, bonds, and exchange-traded funds (ETFs). Opinions expressed are current as of the date shown and are subject to change. They are not intended as investment recommendations.

30 Thank you. Questions?

31 Sanjay Chablaney Panelist Head of ETF Trading Bank of America Merrill Lunch Ugo Egbunike Moderator Director of Business Development ETF.com Tim Coyne Panelist Global Head of SPDR ETF Capital Markets State Street Global Advisors Robert Glownia, CFA Panelist Quantitative Analyst RiverFront Investments Group LLC