European Equity ETFs, Swaps, Futures and Program Trades EDHEC Asset Management Days, Geneva April 2005
Agenda Product Comparison At a glance Uses Pros & Cons The Broker s Role Example: $20M DJ Euro Stoxx 50 for One Year* Execution costs Holding costs Summary Appendix-ETFs Product Matrix Create/Redeem flow chart Misconceptions Listings in Europe Contact Information * Assuming OTC execution in ETF/Swap, Exchange execution in Future/Program Slide 1
ETFs Product Comparison: At a glance Funds Listed on exchange to trade and settle like a stock but can deal OTC Swaps Over The Counter derivatives Trade and settle directly between client and broker counterparty Futures Exchange listed derivatives Centralized exchange trading and clearing house Program Trades Baskets comprising of multiple stocks Trading and settlement as per local market Slide 2
Asset Allocation Equity Fixed Income Commodities Tracking Benchmarks Global Regional Sector Product Comparison: Uses Slide 3
Cash Flow and Equitization Quick and efficient exposure Portfolio rebalancing Hedging Short-term tactical exposure Efficient diversification Core/Satellite Approach Product Comparison: Uses Reduce turnover Active management with passive products Slide 4
ETF Pros Product Comparison: Pros & Cons Open-ended fund Trade and settle like a stock Operationally efficient Expanding product offering Dividends, corporate actions and rebalance outsourced Lending uplift Transparency Potential dividend uplift ETF Cons Fund of fund restrictions Investor misconceptions Fixed costs and stamp tax Immature market Potential cash drag Slide 5
Swap Pros Product Comparison: Pros & Cons Leverage Tailor-made contract specifications Operationally efficient Unlimited benchmarks Dividends, corporate actions and rebalance outsourced Mature European market Transparency Potential dividend uplift Swap Cons Counterparty risk Require ISDA master agreement documentation OTC only market Slide 6
Future Pros Product Comparison: Pros & Cons Central clearing house Low fixed costs Operationally efficient Highly liquid exchange markets for major indices Dividends, corporate actions and rebalance outsourced Future Cons Variable costs Limited indices Minimum block size Monthly or quarterly roll required Potential to trade at premium or discount Require clearing (and give-up) agreements Slide 7
Product Comparison: Pros & Cons Program Trade Pros Portfolio composition flexibility Risk versus share issuer Low fixed costs Lending uplift Program Trade Cons Operationally burdensome Pan-European settlement Dividend, corporate action and rebalance tracking required Slide 8
Education Finding the right wrapper for you Redefining liquidity Identifying the benchmarks Execution Liquidity transformer Pricing and hedging Managing the little things Refining the ETF Market Settlement Lending The Broker s Role Slide 9
Example: DJ Euro Stoxx 50 Execution Costs* The Known Commissions: ~3 bps on Futures, ~8 bps on Program, ~15 bps on Swaps/ETFs Market Impact is the same across products (assume 10 bps for $20M) The Variables Futures mispricing relative to index level, typically < ~3 bps ETF creation cost, if necessary < 1 bp on $20M order Totals ETF ~26 bps cost Swap ~25 bps cost Future ~16 bps cost Program ~18 bps cost * Assuming OTC execution in ETF/Swap, Exchange execution in Future/Program Slide 10
Example: DJ Euro Stoxx 50 Holding Costs* The Known ETF Management Fee 15 bps Future Roll Commission 3 bps * three rolls * two contracts = ~18 bps The Variables Taxes: ETF per fund domicile, Swap per contract, Future implied, Program per client domicile Stock Lending Uplift: ETF ~50-125 bps, Swap implied, Future implied, Program ~25 bps Swap Funding (includes stock lending) Future Roll mispricing < ~3 bps * three rolls = ~9 bps Totals ETF ~35-110 bps uplift +/- dividend taxation and tracking error (< Swap ~Negative funding +/- dividend taxation Future ~27 bps cost +/- implied dividend taxation and stock lending Program ~25 bps uplift +/- dividend taxation and tracking error * Assuming OTC execution in ETF/Swap, Exchange execution in Future/Program Slide 11
ETF Example: DJ Euro Stoxx 50 Summary* ~9-84 bps uplift +/- dividend taxation and tracking error Swap ~25 bps cost + funding cost +/- dividend taxation Future ~43 bps cost +/- implied dividend taxation and stock lending Program ~7 bps uplift +/- dividend taxation and tracking error * Assuming OTC execution in ETF/Swap, Exchange execution in Future/Program Slide 12
Appendix Slide 13
Product Matrix ETF Swap Program Future Classification Fund OTC Derivative Cash / Equity Exchange Derivative Cost of Trading Commission Commission Commission Commission Annual Costs Management Fee Financing spread Custody fee Embedded Interest Rate Bid / Ask Spread As per underlying As per underlying As per underlying As per underlying Liquidity As per underlying As per underlying As per underlying As per underlying Borrow / Lend Yes, immature market N/A Yes N/A Credit Risk Individual or Umbrella fund Counterparty Issuer Central clearing house Dividend Varies, as per fund domicile As per index Paid out Implied in price Coverage 300+, globally Theoretically all indices Individual stocks Major indices Documentation None, trade like equity ISDA agreement None CFTC, etc. registration Miscellaneous Stamp & Creation cost Operationally efficient Stamp cost Roll cost Miscellaneous Holding restrictions Dynamically tradable Rebalance cost Implied div treatment Slide 14
Create/Redeem Flow Chart ETF Creation Process 1. Investor sends cash to AP Create Investor 2. AP delivers stocks to fund manager 3. Fund manager provides ETF shares to AP 4. AP delivers ETF shares to investor 1. AP 4. 2. 3. ETF Redemption is the reverse Fund Manager Slide 15
Misconceptions There is no volume on exchange so it must be illiquid. Brokers are liquidity transformers The ETF is as liquid as the underlying and correlated products Last trade is no where near the bid/offer in the market. Use the NAV as an reference level for an ETFs current value The ETF appears to have tracking error relative to the index. Keep in mind whether the reference index is price or total return and how this relates to the ETFs dividend treatment (reinvested, distributed) Calculate total return for both products and the expected impact of the management fee over a given time period Will I have to pay stamp on a UK listed ETF? ETF shares are stamp exempt BUT, stamp is payable on underlying shares in the primary market so the cost is priced in Slide 16
Asia MSCI and Dow Jones Japan FTSE/Xinhua China 25 US S&P 500 Dow Jones Industrial Average Nasdaq 100 Europe Listings in Europe FTSE 250 Dow Jones Euro Stoxx Midcap & Smallcap Pan-European and Pan-Eurozone Regional ETFs beyond the Euro Stoxx 50 40+ Pan-European and Pan-Eurozone Sector ETFs Multiple listings in multiple currencies to suit your investment needs Slide 17
Contact Information Independently Managed Resources Bloomberg Page EXTF <go> Reuters Page ETFUNDS Todd Scott todd.scott@csfb.com +44 207 888 5441 Slide 18
Disclaimer This material has been prepared by individual sales and/or trading personnel of Credit Suisse First Boston Europe Limited or its subsidiaries or affiliates (collectively "CSFB") and not by CSFB's research department. All CSFB research recommendations can be accessed through the following hyperlink: https://s.research-andanalytics.csfb.com/login.asp subject to the use of a suitable login. This material is provided for information purposes, is intended for your use only and does not constitute an invitation or offer to subscribe for or purchase any of the products or services mentioned. The information provided is not intended to provide a sufficient basis on which to make an investment decision. It is intended only to provide observations and views of the said individual sales and/or trading personnel, which may be different from, or inconsistent with, the observations and views of CSFB analysts or other CSFB sales and/or trading personnel, or the proprietary positions of CSFB. Observations and views of the salesperson or trader may change at any time without notice. Information and opinions presented in this material have been obtained or derived from sources believed by CSFB to be reliable, but CSFB makes no representation as to their accuracy or completeness. CSFB accepts no liability for loss arising from the use of this material.this material is directed exclusively at CSFB's market professional and institutional investor customers ie market counterparties and intermediate customers as defined by the rules of the Financial Services Authority. It is not intended for private customers and such persons should not rely on this material. Moreover, any investment or service to which this material may relate, will not be made available by CSFB to such private customers. Slide 19