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ETF News

Assessing the Merits of an ETF: Debunking Common Myths

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Extract of white paper published by Chris Hempstead, Head of ETF Trade Execution for WallachBeth Capital LLC

With respect to analyzing and selecting ETFs, one of the most common and frustrating mistakes that I overhear is “..unless the fund has at least some minimum AUM ($50mm in many cases), or has average daily trading volume less than [some other arbitrary number] (say 250k shares) it should be avoided…”

Some other arguments against ETFs go so far as to suggest that “..ETFs need to have a certain history or track record before they should be considered…” Adding insult to injury is the claim that “investors are at risk of losing all their money if an ETF shuts down.”

In light of recent articles being picked up by media from New York to Seattle, I would like to dismiss a few of these common, yet unwarranted reasons to avoid an ETF based solely on AUM, ADV or track record.

 First, let’s address AUM:

“ETFs with less than $50mm should be avoided”

In order for an ETF to come to market (list on an exchange) the fund needs to have shares created. This process is often referred to as “seeding”. The ‘seeder’ is the initial investor who delivers into the custodial bank the assets required to back the initial tradable shares of the ETF in the secondary market. ETFs issue shares in what are known as creation units. The vast majority of ETFs have creation unit sizes of 25k, 50k or 100k shares.

When a ‘new’ fund comes to market, they are usually seeded with at least 2 units of the fund. There are very few examples of ETFs that come to market with more than $5mm in AUM or an excess of 200k shares outstanding. One recent exception comes to mind: Pimco’s BOND launched with ~$100mm AUM and 1mm shares outstanding.

Understanding that ETFs have to start somewhere, it would be difficult to explain how more than 55% of ETFs (excluding ETNs, Leveraged ETFs and Inverse ETFs) have garnered AUM in excess of $50mm.

In other words, someone had to take a close look and invest into the funds. The ‘I will if you will’ mentality is probably not how the most successful fund managers find ways to outperform.

Ten of the top thirty performing ETFs year to date have AUM below $50mm.

(EGPT, TAO, HGEM, IFAS, SOYB, PKB, RTL, QQQV, ROOF and RWW)

Congratulations to the pioneers who ‘went it alone’, as they say. Continue reading →

ETF News, People Profiles

MLPs: What You Didn’t Know-ETP Insight From An Expert

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Chris Hempstead, WallachBeth Capital

It took only 18 months for assets in MLP exchange traded products to grow from almost nothing to nearly $7.5bb.

What’s more amazing is that while the number of ETPs available in the market has grown significantly, nearly all of the inflow of assets into MLP ETPs has been captured by only 2 funds:

AMJ–JPMorgan Alerian MLP Index ETN $4.2bb assets under mgmt.

AMLP–Alerian MLP ETF $3.25bb assets under mgmt.

This success story has recently attracted more funds into the space and we expect that trend to continue.

The most recent launches in the MLP space are YMLP (Yorkville High Income MLP ETF) and the MLPA (Global X MLP ETF).

Here is the twist that precipitated this note: JPMorgan has announced (June 14) that they will cap the issuance in AMJ at 129mm notes.

This will bode well for the ETFs tracking the MLP space. A brief explanation below may help shed light on this.

When an ETP no longer allows for creations, the fund starts to trade like a closed end fund. The reasoning behind this is that the arbitrage mechanism which allows market makers to sell the ETP is no longer available. Without the ability to create, market makers may be less inclined to sell the fund short versus a hedge of the underlying assets.

It should be noted that this is only a cap of notes issued. Should the fund reach the cap (we expect it will very soon) and redemptions follow, the fund would allow creates until it reached the cap again.

So what happens now?

We simply wait and see. When AMJ reaches the maximum threshold, we will closely monitor the availability of AMJ notes available in stock loan as well as any premium in the funds pricing on the secondary market.This could bode well in the short term for existing holders of AMJ as the fund will likely trade at a premium once the creation facility is shut down. Early investors would not have expected this so it’s a win for them.

That being said, once this happens I expect investors looking at MLP ETPs will be drawn away from the AMJ ETN and towards the ETFs mentioned above. Why? With the creation facility wide open in ETF funds like AMLP, YMLP and MLPA we expect them to trade and track at or close to their respective net asset values. Continue reading →

ETF News

J.P. Morgan Alerian Fund ETN (AMJ) Already Shows Premium

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  • Brendan Conway, June 22, 2012, 11:16 A.M. ET

The popular exchange-traded note whose share issuance was capped last week by J.P. Morgan Chase (JPM) is already trading at a premium. Investors who hold the JPMorgan Alerian MLP Index exchange-traded note (AMJ) can either cash out now with unexpected profits or they can ride the note’s unusual mechanics higher in hopes of even bigger gains.

But the outcome behind Door #2 is unpredictable. Nobody wants to be holding the bag if JPM suddenly reopens new shares. J.P. Morgan hasn’t said whether it will take that step. But if it does, the investment’s premium, which resembles what you see in closed-end funds, would collapse in a hurry. That’s a risk that investors will bear if they stick with this tracker of rich-yielding master limited partnerships.

The crux of the issue is that AMJ is no longer just a bet on master limited partnerships. It’s also a bet on what other investors who hold or want to hold the same J.P. Morgan note will do.

At the moment, there’s a 45-cent premium in AMJ’s market price versus the underlying assets, or about 1.2%. It will get bigger if more investors pile in.

“This is a free gift. But how long do you watch the premium build before you sell the shares out? It’s a question that the owners of AMJ have to ask themselves,” Chris Hempstead, a director at WallachBeth Capital tells Barrons.com.

ETF News

“How Do You Like Them #Apple(s)?

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Courtesy of post-distribution desk notes from WallachBeth Capital’s ETF Execution Expert, Chris Hempstead..

8am Monday June 11

Maybe Apple can solve the world’s problems. We find out today!

As global markets react positively to the news of yet another ‘solution’ to the European debt crisis, a soft poll of peers reveals they are not as cautiously optimistic as the tape might indicate.

The latest announcement of a $125bb rescue package for Spanish banks seems like yet another attempt to hold back an incoming tide with a pile of sand. For those of you who don’t spend time at the beach, it does not work; the water always finds a way around it and eventually consumes it.

With that in mind and more importantly should you be looking for creative ideas to take a contrarian view against what could be a short term rally, and it seems as I write this the markets have thrown in the towel already, there was a nice little article in the WSJ this morning about a little known ETF, HDGE– The Active Bear.

Additionally there was a write up on Seeking Alpha highlighting the highs and lows of HDGE since its inception in January 2011 as well as worthy comparisons versus –SDS-Proshares Ultra Short S&P 500 over both the short and long term.

HDGE is an interesting and unique actively managed ETF as there are no others like it. The fund managers Brad Lamendsdorf and John Delvecchio run the portfolio of short equities. While some other ETFs exist with partial short positions, the HDGE is all short all the time and it is NOT a leveraged fund. Continue reading →

ETF News

High-Yield ETFs Lure Investors Bypassing Dealers: Credit Markets

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reporting from Lisa Abramowicz

Exchange-traded funds that own junk bonds are attracting unprecedented sums of cash from institutional investors seeking to slip in and out of the market as dealer inventories decline.

Institutional holders own 51 percent of BlackRock Inc.’s high-yield ETF, up 11 percentage points this year, according to data compiled by Bloomberg. The portion at State Street Corp. (STT)’s fund has grown to 60 percent, a rise of 18 percentage points.

The two funds, which allow individual investors access to the junk-bond market for as little as $37.59 a share, are attracting buyers from Bank of America Corp. (BAC) to Northern Trust Corp. as primary dealers gut corporate bond holdings by 81 percent since 2007. The market shift was underscored last month, when an investor redeemed as much as $780 million shares in State Street’s fund for the equivalent amount of bonds.

“Liquidity is the main reason that we’re using high-yield ETFs right now rather than high-yield bonds,” Tim Anderson, chief fixed-income officer at RiverFront Investment Group LLC in Richmond, Virginia said in a telephone interview. “In the good old days you could call up one of the major firms and there’d be a halfway decent shot you could sell $15 million, $30 million of bonds to them on the line,” said Anderson, whose firm is the sixth-biggest institutional shareholder in State Street’s fund. “They’re not keeping the same inventories anymore.”

“ETFs have increasingly become a more viable way to express credit views,” said Eric Gross, a credit strategist at Barclays Plc in New York. “We’ve seen corporate bond liquidity go down across both investment grade and high yield.”

“As long as something like JNK or HYG is easy to trade and relatively liquid, I’m not sure why anyone would go through the hassle of chasing down all the bonds, unless they were very good at doing it,” said Chris Hempstead, director of ETF execution at WallachBeth Capital LLC in New York. “It may be an affordable way to get exposure to the bonds.” Continue reading →

ETF News, Strike Price

UofMass Study: Option Collar Strategies Deliver Better Performance With Less Risk

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As reported by Pension&Investments Magazine, a newly-published research report from the University of Massachussetts has found options-based collar strategies would have outperformed the market in most asset classes, while providing drastically reduced risk leading up to the 2008 financial crisis, AND as well, throughout the subsequent recovery.

“The contagion across asset classes during the financial crisis suggests that protective options-based investment strategies, such as collars, when implemented on a wide range of asset classes, could provide portfolios with greater downside risk protection than standard multi-asset diversification programs,” according to a summary release of the report issued by the Options Industry Council, which helped sponsor the research by Edward Szado and Thomas Schneewies. Mr. Szado is a research analyst and Mr. Schneewies a professor of finance, Isenberg School of Management, University of Massachusetts.

The research covers the 55 months from June 2007 to Dec. 31, 2011, and expands on a 2010 paper that studied the effects of a collar strategy against the PowerShares QQQ ETF from 1999 to 2010.

The authors evaluated the impact of collar strategies against ETFs across a wide range of asset classes such as equities, commodity, fixed income, currency and real estate, based on a set of rules where a six-month put option is purchased and consecutive one-month calls are written. While Australian dollar and Japanese yen currency ETFs, two bond ETFs and Nasdaq and gold ETFs outperformed the collars, the strategy outperformed other ETFs across asset classes while providing significant risk protection. Continue reading →

ETF News, People Profiles

Narrowing Spreads for Illiquid ETFs

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Excerpts Courtesy of James Armstrong/Traders Magazine

For some illiquid exchange-traded funds, the price isn’t always right. Spreads can be unreasonably wide, luring the less informed to take the bait and accept a price that is far from reasonable. Fortunately, those spreads are slowly narrowing due to competition.

With illiquid funds, the screen does not always match what an ETF is really worth. If a fund rarely trades, both the bid and the offer will be posted by professional trading shops and will be skewed to a premium or a discount. That means spreads can be more than a dollar wide at times.

Even if liquidity is present, it’s not showing up in the posted prices. Recent data from Index Universe shows more than 10 percent of ETFs still have spreads of 100 basis points or more. The vast majority of those funds have an average daily volume of fewer than 5,000 shares.

Many in the industry are trying to help investors who want access to these lightly traded ETFs but don’t want to get soaked every time they buy or sell. Gradually, they are starting to get some of those spreads down to more reasonable levels, though certain funds still have a way to go.

High-Touch + High-Tech Approach

The agency shop WallachBeth Capital has built a niche for itself with ETFs that trade in lesser quantities. Though liquid ETFs can be plugged into algos without much of a problem, less liquid ones cannot, so WallachBeth combines high tech with a high-touch approach to its trading. The firm uses a highly-sophisticated trading technology platform to support its ETF desk of 12 traders to find liquidity that doesn’t show up on the screen.

Andrew McOrmond, managing director at WallachBeth, said if a broker only calls one or two people, and counterparties know there isn’t much competition for that order, they won’t get the best price. But when a firm calls 22 people, he said, and their counterparties are aware of this, firms on the other side tend to give their best price rather than dangle an outlier number in hopes of catching a big spread.  Continue reading →

ETF News, People Profiles

Does Size Really Matter? (with ETF Returns)

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According to Benzinga.com’s ETF Professor, its not necessarily the size of the ETF, but the motion when it comes to investor returns.

From Benzinga’s April 23 edition:

“..There are plenty of instances in life when bigger is better. When it comes to exchange-traded products, bigger isn’t always associated with better [4]. At least when it comes to what should be investors’ primary consideration: Returns.

It has been documented that ETFs and ETNs with low average daily volume [5] and an assets under management number that may not be viewed as impressive by the so-called experts can outperform. In fact, all investing in an ETF with a bigger AUM total does is lead investors to a bigger fund, not larger returns [6].

Fortunately, a move away AUM and average daily volume as the primary determinants of an ETF’s worth is already under way.

“Some of the traders we talk to are using AUM and ADV a lot less now,” said Chris Hempstead, head of institutional sales and trading at WallachBeth Capital. “Some hedge funds using ETFs to hedge might use the larger ETFs because they just need short-term exposure, but buy-side traders are using AUM and ADV less and less.”

The statistics back up the assertion that bigger isn’t always better with ETFs. In an interview with Benzinga, Hempstead noted that in the case of the nine Select Sector SPDRs, all have been outperformed by a comparable fund of smaller stature on a year-to-date basis. Continue reading →

ETF News, People Profiles, Strike Price

Institutions Eye Options: Buy-Writes and Butterflies

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Yes, the equities markets are on a roll; the bulls are boisterous, and the “buy and holders” are popping champagne corks. Given this scenario, who would even suggest the idea of a fiduciary fund manager employing option-based hedging strategies that can potentially cut into upside returns?? After all, even though major exchanges throughout the globe have facilitated option-based hedging products for almost 30 years, options are “too complicated,” right?

OK, I’ll admit that I’m hearing about the “growing number” of large institutional managers that are using options, but options are just too complicated for all but those few MIT-educated portfolio managers who have found themselves working for a select group of forward-thinking and open-minded institutions.

Am I right?? I mean, gee–if I’m a long-only hedge fund, an RIA, an endowment, a pension manager, a family office, or a corporate treasurer, I have to not only figure out what a strike price is, but I need to figure out the difference between a call and a put, I have to consider tax implications, calculate break-even points, and I have to worry about the risk of stocks being “called away”, and when that happens, I lose out on the gains that I know will come, because I only pick stocks (or ETFs) that will go up at least 10%-15% within a few months of buying them, and more likely, 20%-30% over the next two or three years.

Well, if you’re a fund manager that’s been walking and talking the markets for more than a few years, you might know that bulls and bears make money, and pigs get slaughtered. Other than single stocks such as AAPL, equities markets (just like any other asset class) are cyclical. Prices go up, down, or they go side-ways.

Surprise! After almost 30 years of tepid use by fund managers handcuffed by mandates, the use of options by responsible and conservative institutions is finally gaining traction. Continue reading →

ETF News, People Profiles

Hearing is Believing: ETF Best Ex Expert Says…

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As US equity indexes search for a trading session bottom from which to bounce today, traders are slamming their phones in frustration when discovering the screen markets are as clear as a very cloudy day. Nothing new on that front..as ETF market experts will repeatedly repeat “don’t expect to find deep liquidity on the screens, expect to find it courtesy of connectivity..”

To hear it from the horse’s mouth, this BloombergLP-inspired podcast with Chris Hempstead, head of ETF execution for WallachBeth Capital is a good listen. Click this link: ETF Liquidity Interview

ETF News

Despite Rally, US Market Lags List of 35 Best Global ETF Markets

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We just scored the most recent trading desk comments courtesy of   WallachBeth Capital’s Chris Hempstead.

” Last week I took a look at YTD performance of the US Equity based ETF’s with exposure to the S&P sectors.

Today I would like to broaden that view and simply rank and look at the YTD top performing Equity based ETF’s globally.

What sparked my interest in creating this list was my curiosity to see how far down the list I needed to go before I found the top US Equity ETF. I wasn’t expecting it to be so far down the list, however I am not surprised that it was biotech for being the US market sector group which has been on the biggest tear in the US Continue reading →

ETF News, People Profiles

Expert ETF Trader: Liquidity Is There; Just Look Beyond the Screens

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Other than the ETF market “go-go names”, one of the more commonly-voiced, and according to many, often-misguided observations regarding most ETFs is  “won’t trade it, there’s no liquidity in that name,”  or “the screens are only showing 1000 shares offered and I have to pay up 50 cents to buy a lousy 25,000 shares?!”

As a consequence, any half-smart portfolio manager often quickly (if not wrongly) concludes that the “lack of liquidity cost” is a deterrent to their positioning what is otherwise a very compelling “basket” of underlying securities.

The editors here don’t buy into the lack of liquidity notion, and after getting our hands on desk notes published today by Chris Hempstead, Head ETF Trader for WallachBeth Capital (one of the more prominent players in the ETF space), we couldn’t resist the opportunity to re-publish.

But wait, there’s more!

ETF News, People Profiles

ETF Market’s “Dame Deborah” Fuhr Launches Independent Research Firm

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Debbie Fuhr, the undisputed “Dame” of the exchange-traded-funds industry, and most recently BlackRock’s Managing Director and global head of ETF research and implementation will open the doors of a new independent research firm, “ETF Global Insight” next Monday. Prior to Debbie’s 3-year stint at BlackRock/BGI, she was billeted for 11 years at Morgan Stanley’s London barracks where she was an MD and head of that firm’s  investment strategies group.

photo courtesy of CNBC

As reported by a variety of global business news outlets, Debbie’s new domain “will publish research on the ETF industry as well as providing education and assistance with product comparisons and asset allocation implementation.”  Debbie will be joined in this new  London-based boutique by former co-workers Shane Kelly and Matthew Murray. All three are widely-credited for developing the first ETF industry research reports.

While speaking to FT.com reporter Chris Flood in discussing the new firm, Debbie stated, “All the members of the ETF eco-system have been citing the need for more and better independent education and research to help navigate the now vast array of products that are available.”

Observed  Andy McOrmond, co-head of ETF Trade Execution for institutional broker  WallachBeth Capital and a long-time industry associate of Ms. Fuhr,  “Debbie is an industry icon, and her new focus on providing an independent perspective on the broad array of ETF products will undoubtedly prove to be a bonus for those keeping their fingers on the pulse of the ETF market place.”