Archives: October , 2012
Strike Price

CFTC Proposes to Break Up Derivatives Market Trades; ’15-Second Rule’ Draws Fire

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  Courtesy of WSJ Reporter Scott Patterson

WASHINGTON—Swaps trading is one the last bastions of Wall Street where brokers arrange deals over the phone.

That clubby way of doing business could go the way of the rest of Wall Street, where trading takes place on computers, under a roughly 500-page draft set of rules designed to push the market away from the opaque world of over-the-counter, phone-based trading, into more transparent electronic venues.

The thinking: Open markets are safer, cheaper and less prone to manipulation.

The rules, circulated Thursday at the Commodity Futures Trading Commission, lay out guidelines for so-called swaps execution facilities, or SEFs, the electronic trading venues for swaps mandated by the Dodd-Frank financial overhaul of 2010.

Originally proposed in early 2011, the final version of the rules have been widely anticipated by bankers, brokers and traders who dominate the multitrillion dollar market for swaps, complex contracts in which firms “swap” the returns on assets such as currencies, energy products and interest rates.

Among the most contentious parts: the so-called 15-second rule, which requires firms that have negotiated a trade between two parties to post the trade on a SEF for 15 seconds before executing it and giving other market players the chance to offer a potentially better deal.

That could keep brokers from doing many trades over the phone, which is how much swaps trading is done today, without exposing the deals to the rest of the market.

As it stands, the rules are certain to meet opposition from swaps-trading firms whose business could be threatened. Industry players, from giant banks to global brokerage firms, have lobbied heavily to water down the SEF rules for more than two years.

The original SEF proposal sparked a firestorm of industry complaints. The final rules will be reviewed by CFTC board members, who could potentially vote on it at a Nov. 15 meeting. The rules are subject to negotiation and the final version could be different from what the agency proposed this week.

Several commissioners have expressed concerns about how the 15-second rule works and whether it is fair to investors. The rules aren’t set to take effect until 2013.

Backers of the 15-second rule say it gives other trading firms the ability to post more competitive bids and offers, making the swaps cheaper to trade and prices more transparent. Continue reading →

ETF News, Tech Talk

What’s Next for ETF trading?: NASDAQ’s “iNAV pegged order types”

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The Nasdaq stock market submitted paperwork to regulators proposing fuller use of intraday net asset values (iNAV) in the pricing of equity ETFs, arguing that the integration of such a real-time pricing mechanism will limit the poor trade executions that dog the world of exchange-traded funds.

While ETF traders and market makers would still be able to use plain-vanilla market orders to transact, the second-biggest U.S. stock exchange said the ETF iNAV pegged orders it is proposing constitute a viable way to capture changes in ETF prices that will truly reflect the fact that iNAV is updated every 15 seconds.

Nasdaq noted that under the prevailing system iNAVs are typically calculated using the last sale prices of the fund’s components. But it stressed that iNAVs can vary from the fund’s market price and/or can be valued outside of the fund’s prevailing bid/ask spread as a result of the supply and demand characteristics of the fund and/or liquidity present in the marketplace.

“The INAV Pegged Order type will be available for all U.S. Component Stock ETFs where there is dynamic INAV data and will offer market participants a greater level of transparency as to fair value, by bringing what has historically been a post-trade analytics tool into the pre-trade environment,” Nasdaq said in the filing that was dated Oct. 12.

“More importantly, the INAV Pegged Order should minimize the disparity between the market execution price and the underlying fund’s value,” Nasdaq said. “As the INAV changes, so move the INAV Pegged Orders.”

The exchange said that under its proposal, which is an amendment to Rule 4751, should the iNAV data feed for a particular ETF be compromised or temporarily stopped being disseminated, it would suspend the use of the iNAV pegged order type for that ETF until it was confident the system’s integrity had been restored.

“ETF Sponsors routinely deal with investors that have been subject to inferior executions,” the filing said. “These complaints are almost unanimously as a result of people using market orders where the prevailing bid/ask in the market does not necessarily correlate to the fund’s value, and the quoted size does not meet the demand of the order. The INAV Peg will also help to protect investors against any unintended overpayment for the security.”

Nasdaq said that if the SEC approves its rule change proposal, it could become effective in no sooner than 45 days, though the commission could request extra time to deliberate as to whether the rule should be approved.

The exchange also solicited public comments, data and arguments regarding the proposal.

ETF News

A Silver Bullet: Corporate Bond ETFs Dressed Up to Look Like Bonds

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By Jason Kephart

 

BlackRock Inc.’s exchange-traded fund arm, iShares, plans to launch a series of corporate bond ETFs that look and act like individual bonds.

The proposed series of iShares Corporate Bond Funds will be a set of target-date ETFs, each holding a basket of investment-grade bonds set to expire in their given year. The San Francisco-based ETF provider already offers a similar suite of products that hold municipal bonds.

Fixed-income ETFs have been in high demand for the past two years as investors look for more targeted and liquid access to bond markets. Bond ETFs had $39 billion of inflows through the end of September, the most of any asset class, according to Morningstar Inc. That puts them on pace to beat last year’s record inflows of $43 billion, which were more than double those in 2010.

Even with the sudden popularity, bond ETFs have a long way to go to catch up with their equity siblings, which hold more than $900 billion.

Mark Wiedman, global head of iShares, said he thinks target-date bond ETFs are one of the ways bond ETFs are going to catch up to equities, as they’re more like what the typical bond investor is familiar with.

Mr. Wiedman explained that some traditional fixed-income investors aren’t fully on board with bond ETFs because they don’t know enough about them yet. Others are put off by the fact that the funds come with a ticker symbol and trade intraday, making them resemble a stock rather than a bond.

“Fixed-income people don’t get ETFs,” he said at last month’s Morningstar ETF Invest Conference in Chicago. “We need to make them look more like a bond.” Continue reading →

ETF News

Debunking The Myth re: ETF Spreads

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A daily double courtesy of IU’s Dave Nadig

ETFs can be more efficient than the stocks they track, even in surprising places.

At almost every conference and ETFs 101 webinar we do, you’ll hear us saying again and again that spreads matter.

In fact, getting investors to understand the importance of spreads, depth of book, and limit orders make up the bulk of the live trading sessions we do.

After all, next to expense ratios, the spreads and commissions you pay on your ETF trades are one of the only things knowable in advance and, depending on your time horizon, they can have a real impact on your performance.

One of the maxims we always put out there, almost as an oddity, is that ETFs can often be more efficient than the stocks they’re composed of. We usually pull a chart of an extreme case to prove the point: an enormously liquid ETF, like the iShares Emerging Markets ETF (NYSEArca: EEM) and its comparatively wide-spread and thinly traded stocks—thinly traded by New York Stock Exchange standards, anyway.

When it came time to update the chart, however, I took a different approach.

Instead of hunting for illiquid underlying stocks and super-liquid ETFs, I went for the opposite. I cast around for an example of an ETF with thin volume, where the portfolio was small enough so that most investors could, if they wanted, just buy all the stocks themselves. Surely in such a case, the spreads of the liquid stocks would beat the spreads of the illiquid ETF, right?

Software was the perfect place to look, and IGV was our poster child. IGV is the iShares S&P North American Technology-Software Index Fund (NYSEArca: IGV). It holds 54 stocks, including some of the most liquid companies in the world, like Microsoft and Oracle. IGV, however, is a wee bit less liquid, trading less than 50,000 shares on an average day.

To see the full article, click here!

ETF News

Errors Abound When It Comes to ETF Tracking Errors

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Courtesy of Dave Nadig

Here’s how I know the ETF Revolution has long since passed, and what we’re living in now is the new ETF normal: The questions from advisors are getting a lot smarter.

I used to get emails about how creation and redemption worked. Now I get questions about tracking error.

Unfortunately, most people think about tracking error all wrong.

Here’s a perfect example. Take two funds that have been in the headlines a lot these past few weeks, the Vanguard MSCI Emerging Markets ETF (NYSEArca: VWO) and the iShares MSCI Emerging Markets Index Fund (NYSEArca: EEM).

Now imagine you’re a Sophisticated Investor. You know a few things: You know expense ratio matters. You know spreads matter. You know tracking error matters.

So you pop up your Bloomberg, and here’s what you see:

 

 

Even on trading, Vanguard wins on expenses. But Holy Meatballs Batman, what are those guys down in Pennsylvania doing!? A tracking error of 4.433 percent?

And at this point, many advisors will make a critical mistake, assuming that the Vanguard fund is horribly mismanaged. It’s not an unreasonable assumption, if in fact this was an accurate tracking error number. But it’s not.

Remember, academic tracking error is the annualized standard deviation of daily return differences. If the index is up 1 percent today, and VWO is up 0.95 percent, well, that’s -.05 percent to add to the series. Take that whole series, plug it into your stats package, get the standard deviation, annualize it, and there you go.

There are a few reasons this is all a terrible idea. First of all, imagine that VWO was actually missing its mark by 0.05 percent, day in and day out. Well, the standard deviation of those daily differences will be zero. It’s enormously consistent. Continue reading →

ETF News

ETFs that “Tilt” for Institutional Investors

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  Courtesy of Rosalyn Retkwa

Most ETFs are still designed to track an index passively at a low cost. But the market can support only so many ETFs that simply copy an index, and with actively managed ETFs still problematic, there is a growing category in between: ETFs that use “factor-based strategies” to reweight indexes in favor of factors other than market capitalization. Such ETFs are still in the passively managed camp because once they establish their rules for reweighting, they have to follow those rules, but they’re not plain-vanilla passive, either.

“A lot of the new index funds deviate away from market cap and try to implement strategies that add performance over the market cap performance,” says Samuel Lee, the editor of Chicago-based Morningstar’s newsletter, ETFInvestor. “The most common type of non-market-weighted strategy is the value strategy, where stocks are cheap by some sort of fundamental accounting measure — price-to-earnings, price-to-book or price-to-cash-flow,” he says. But there are a number of factors that can be used in reweighting indexes, for instance, “company size is well accepted as a factor,” he says.

The newest factor-based ETFs to hit the market are the “tilt index” funds from FlexShares, sponsored by Northern Trust of Chicago. In its product literature, FlexShares describes its tilt funds as “applying a nuanced ‘tilt’ methodology” that weights its portfolios more towards small-cap and value stocks. The funds still include large-cap and growth stocks, but “seek to counterbalance the inherent bias toward large-growth companies embedded in market-weighted strategies,” the firm says. Continue reading →

ETF News, People Profiles

Axing the Taxes Using ETFs

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By Ryan Issakainen

Ryan Issakainen is an exchange-traded fund strategist for ETF provider First Trust.

WHEATON, Ill. (MarketWatch) — One of the biggest attractions of exchange-traded funds is that they are often considerably more tax-efficient than mutual funds. Many ETFs regularly take steps to avoid the annual capital gains distributions that can disrupt the tax planning of investors in traditional mutual funds. With year-end tax considerations coming into focus, this is a factor investors should consider.

The process by which ETF shares are created and redeemed is the key to the tax efficiency they enjoy. For most equity-based ETFs, the creation/redemption of shares is a function of large institutional investors making so-called in-kind exchanges of shares in an ETF’s underlying holdings for large blocks of ETF shares known as “creation units.”

Through this process ETFs are able to grow and contract without the necessity of buying or selling securities, a move that could result in capital gains, thus triggering taxable distributions to investors.

Yet when it comes to taxes, investors should always remember that not all ETFs are the same. The tax efficiency associated with “plain vanilla” ETFs does not carry through for all exchange-traded products.

For example, levered and inverse ETFs are often less tax-efficient because these funds generally use a high level of portfolio turnover to achieve their objectives. They increase and decrease exposure to various asset classes on a daily basis via derivatives, such as swaps and futures contracts. As a result, many levered and inverse ETFs have historically made substantial capital gains distributions.

Additionally, there are a few odd cases in which ETFs may produce less tax-efficient exposure than their underlying holdings. Such is the case for ETFs that track master-limited partnership (MLP) indexes. When an ETF allocates more than 25% of its portfolio to MLPs, it no longer qualifies as a tax-exempt, regulated investment company; instead, these funds are subject to federal corporate income tax. This tax liability is reflected in the daily calculation of a fund’s net asset value, which has often resulted in significant tracking error between MLP ETFs and the indexes that they follow. Continue reading →

ETF News, Tech Talk

Tradeweb to Launch European ETF “Trading Hub” with “RFP” model

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Courtesy of IndexUniverse.eu Rebecca Hampson

The electronic trading platform for exchange-traded funds launched at the end of last month by electronic market place provider, Tradeweb, has been backed by ETF issuer, Source who says that it will create a central hub of liquidity in Europe, which the market currently lacks.

Michael-John Lytle, managing director at ETF issuer Source, told IndexUniverse.eu: “In Europe, US$3bn of ETF trades take place on-exchange daily.  This is much less than in the US where, on average, US$50bn is traded. This move has the potential to expose the other two thirds of European market flows which trade over-the-counter (OTC). Transparency can in turn encourage further liquidity and this is vital to a thriving and growing ETF market. Hence, it is a very exciting development.”

He said: “Liquidity in the European ETF market is very fragmented and this platform has the potential to capture a meaningful portion of OTC liquidity in Europe.”

Tradweb’s platform will allows buy-side firms access to 5,000 European-listed ETFs’ prices on request. Because of the transparent nature of the platform it is hoped that it will boost trading and encourage more market participants to join.

Lytle said: “The platform will facilitate large trades that would be challenging to execute on-exchange.  These OTC transactions are currently executed over the phone.  This platform will allow an investor to simultaneously collect prices from up to five market makers.  If it is successful, this will be a big step forward for the European ETF market.”

“Tradeweb already has 11 ETF market makers on board and a couple of dozen clients. It also has a tried and tested technology platform used widely in fixed income. Concentrating flows in one venue has the potential to centralise and expose a meaningful amount of OTC activity.”

“Any e-trading platform that requires multiple mouse clicks in effort to first source block liquidity, wait for responses for bids and offers, and then execute a transaction needs to be populated at the outset with credible and actionable liquidity, otherwise I’m still much better off relying on the new hybrid “high-touch/high-tech liquidity aggregators” who leverage technology and navigate the OTC market-maker ecosystem.”   Continue reading →

ETF News

Europe Dividend ETFs Offer Big Yields

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Courtesy of  Daniela Pylypczak

Amidst the seemingly never-ending eurozone drama, there have been some surprising bright spots in the space: Europe Dividend ETFs. These products have managed to maintain their footing, while at the same time provide investors with relatively handsome dividend yields.

Currently, there are only two funds whose sole objective is to target dividend-paying companies from Europe. And while these two ETFs focus on the same geographical region, their methodologies, portfolio composition and resulting dividend yields are noticeably different.

STOXX European Select Dividend Index Fund (FDD)

This offering from First Trust offers investors exposure to 30 of the highest-dividend yielding stocks from roughly 18 different European countries. Considering that FDD’s underlying index is dividend-weighted, it is perhaps not surprising to find nearly 45% of the fund’s total assets allocated to the its top 10 securities, making the 30-stock portfolio rather top-heavy along and relatively shallow. Although FDD’s portfolio composition might deter some investors, its ability to deliver juicy yields to its investors may prompt some to give this fund a closer look. Currently, FDD’s annual dividend yield is 4.98%, the highest among the Europe-specific dividend ETFs

Europe SmallCap Dividend Fund (DFE)

WisdomTree’s DFE allows investors to make more of a “pure play” on the European economy, while at the same time maintaining relatively high dividend yields. DFE invests in small cap European stocks, an asset class that is often overlooked by most Euro-focused ETFs. Continue reading →

ETF News

Vanguard’s CIO Gus Sauter: Agency Execution is our Preference

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  Courtesy of  Gregory Bresiger.. Excerpts from Part 3 of a series of interviews with Vanguard Chief Investment Officer Gus Sauter

How does Vanguard Funds,’ famous for Fred Mertz like trading economy, go about finding the lowest possible costs? The process is detailed in Part Three of Traders Magazine’s Q&A with Vanguard chief investment officer Gus Sauter.

Traders Magazine: Why have you and your company launched this campaign to change what you perceive as an overpriced market structure?
Gus Sauter: I think transaction costs are surprisingly high.

Traders Magazine: You said in an interview that “a large part of indexing is actually being a trader.”  Does mean that, as with most traders, you’re using algos and using agency traders like ITG or Instinet. How does it work out for Vanguard?
Gus Sauter: We do most of our trading through agency brokerage. We will use brokers’ algos as well if we think that is appropriate for trading. We monitor the transaction costs on a broker by broker basis.

Traders Magazine: Even index fund managers need the same trading skills as though who are actively managing funds?
Gus Sauter: Yes, it really is important that our portfolio managers understand how to trade, how to execute, how to find the right strategies and venues. Should it be an algo or something they are using a dark pool.

Traders Magazine: Higher than most investors think?
Gus Sauter: Yes, a lot of people don’t realize how much money you could spend on transactions if you’re not careful. In other words, we trade hundreds of billions of dollars a year. If you lose , just a half a percent, you’re losing a billion dollars.

Traders Magazine: The implication of what you’re saying is the industry, especially in good times, is incredibly sloppy. Is it because it is other people’s money?
Gus Sauter: Yea, hard for me to tell you. Historically, people have never had respect for the magnitude of transaction costs. They really felt they provided so much alpha in their actively managed funds that they really didn’t have to worry about transaction costs.

Traders Magazine: Not over the past decade…
Gus Sauter: Yes, in a lower return environment people really recognize how much costs are.  And they are devoting more time to how they trade.

 

Full article: http://www.tradersmagazine.com/news/vanguard-sauter-brokers-capital-110393-1.html?zkPrintable=true

 

ETF News

IndexIQ Launches QMN: Latest in Innovative Family of Absolute Return Hedge Fund ETFs

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IndexIQ, a leading developer of liquid index-based alternative investment solutions, is launching the newest addition to its Exchange-Traded Fund family, the IQ Hedge Market Neutral Tracker ETF (QMN), on October 4, 2012, it was announced today. QMN is designed to offer investors liquid, transparent Market Neutral hedge fund exposure.

QMN will seek to track, before fees and expenses, the performance characteristics of the IQ Hedge Market Neutral Index (IQHGMN), part of IndexIQ’s proprietary IQ Hedge family of benchmark hedge fund replication indexes. The IQ Market Neutral Index (IQHGMN) has live performance dating from September 2008.

“Market Neutral is one of the largest hedge fund investment styles, both in terms of the number of funds and in the amount of assets being put to work,” said Adam Patti, IndexIQ CEO. “After incubating the index underlying QMN for four years, we felt it was an excellent time to roll out this strategy, particularly given the volatility and uncertainty inherent in today’s market environment. As we add QMN to our fund family, IndexIQ now has ETFs for investors who want to gain liquid, transparent, low cost exposure to Market Neutral (Ticker: QMN), Global Macro (Ticker: MCRO), and Hedge Funds of Funds (Ticker: QAI). We’re very pleased to be the pioneer in yet another area of the alternative investment landscape.”

Fully story here

ETF News

Vanguard Drops MSCI..

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Widely reported..and excuse our delayed tape i.e. dissemination.

Excerpt courtesy of IndexUniverse

Vanguard, the world’s biggest mutual fund company, has decided to segue away from some MSCI indexes over the next several months in favor of benchmarks created by FTSE. The move was motivated in part by lower index licensing costs and will involve its $67 billion Vanguard MSCI Emerging Markets ETF (NYSEArca: VWO).

Vanguard’s switch affects six international equity funds that had total assets of $170 billion as of Aug. 31, FTSE said today in a press release, noting the transaction was the largest ever international index-provider switch. The switch leaves iShares, the world’s biggest ETF firm, as the ETF firm with the deepest ties to MSCI.

The six funds will change to benchmarks in the FTSE Global Equity Index Series, replacing MSCI, and VWO and the index mutual fund of which it is part will be based on the FTSE Emerging Index, FTSE said. One huge difference is the absence of South Korea from the FTSE index, while the MSCI index weights the country at around 15 percent.

In its own press release, Vanguard said that in addition to the six international benchmarks moving to FTSE indexes, it also plans to switch indexes on 16 U.S. stock and balanced index funds to benchmarks developed by the University of Chicago’s Center for Research in Security Prices (CRSP)—a leading provider of research-quality, historical market data and returns. The existing indexes on these U.S.-focused funds are also provided by MSCI.

Full story: Click Here for IU update

ETF News

ETFs That Mature Like Bonds : Guggenheim Gets It

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  Courtesy of WSJ Reporter Daisy Maxey

While growth hasn’t been explosive, one family of defined-maturity ETFs, offered by Guggenheim Investments, a unit of Guggenheim Partners LLC, has grown to $1.6 billion since the first funds were launched about two years ago. And a defined-maturity municipal-bond fund group at BlackRock Inc.’s iShares unit has attracted about $220 million.

These ETFs seek to combine the diversification of a bond fund with the fixed term of an individual bond. A fund with the year 2015 in its name, for instance, will hold bonds that mature in that year—and it will liquidate by the end of that year.

But while the interest payment and face value of an individual bond are spelled out up front, the funds’ monthly distributions and payouts at maturity may fluctuate some. “It’s a little different structure” for investors to learn about, says Timothy Strauts, an ETF analyst at researcher Morningstar Inc.

The ETFs were designed partly to be building blocks in a “laddered” bond portfolio, where investors buy bonds with staggered maturity dates and hold them to maturity. Traditionally, laddering was done with individual bonds, but getting sufficient diversification can require an investment of $500,000 or more.

Investment advisers are the biggest buyers of the funds, but many wanted to see how the funds worked at maturity before buying, says William Belden, head of product development at Guggenheim. Guggenheim BulletShares 2011 Corporate Bond liquidated successfully at the end of last year, the first in the series to mature, and more advisers are now showing interest, Mr. Belden says.

See the WSJ for the full article.

Continue reading →

ETF News

The “ETF bid” and Feedback Loops: Corporate Bond ETFs

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Courtesy of Brendan Conway

They’re calling it the “ETF bid” — the idea that corporate bond prices get juiced when passively managed funds have to buy them. It’s known to happen in thinly traded stocks in some instances. So it shouldn’t come as a surprise that thinly traded, idiosyncratic markets like high-yield bonds are seeing a similar effect. It’s the cautionary part of an otherwise pretty encouraging story: ETFs’ power to crack open hard-to-reach asset classes for more investors.

This week’s print Barron’s ETF Focus on the subject concludes that investors should be especially wary of selling passively managed bond funds when markets turn bearish — that’s often the best time to buy. And investors who buy these ETFs when markets feel rosy pay a premium for the service. Obviously, it’s best to avoid paying extra if possible.

Yes, it’s the same old advice, to be a contrarian investor. But ETFs are only growing in importance in the bond markets. The more heavily they are traded, the more investors have to pay attention to their pricing dynamics — and that’s true even for those who don’t use ETFs. If you haven’t read our Barron’s print column, one of the key findings comes from Goldman Sachs’ (GS) Charles P. Himmelberg and Lotfi Karoui. The duo estimate that a monthly rebalanced portfolio of bonds tracked by the iBoxx $ Liquid Investment Grade Index, the benchmark driving the $24.5 billion iBoxx $ Investment Grade Corporate Bond Fund (LQD), has beaten comparable non-indexed bonds by roughly 4.7%, or about 1% a year, since the beginning of 2009.

Great, right? Well, not always. Index bonds also appear to sink harder during bad times, as they did late last year.

In this vein, we wanted to point out a meticulous look at how this works in practice, from TF Market Advisors’ Peter Tchir. Continue reading →