4:00pm
Wealth Peer Group meeting (Music Room)
4:45pm
ETFs explained – Mick Gilligan, Killik & Co (Music Room)
5:45pm
Champagne Reception (Paul’s Terrace) with Fine Violin Fund presentation – Florian Leonhard
6:30pm
Evening buffet (Music Room)
7:15pm
Cash Management presentations (Music Room) Toby Allebon, Investec – Investec High 5 Deposit Henry Buckmaster – Prime Rate AAA rated Money Market Fund Ulf Blacher, ZAN Partners Tri-Party Repo Exchange (T-REx)
8:15pm
Sweets and coffee (Music Room)
9:00pm
Close
Exchange Traded Funds (ETFs) Mick Gilligan, Research Department May 2009
What are Exchange Traded Funds (ETFs)?
Background – Size of market, range of asset classes Comparison: ETFs v other structures Mechanics – how do ETFs work? Liquidity – Spreads & volumes Costs – explicit & implicit Investment strategies – using ETFs Summary
What are Exchange Traded Funds? (1) Listed securities designed to closely track an index or commodity.
Hybrid between shares and conventional open-ended funds (e.g. OEICs).
Low cost
LARGEST LONDON LISTED ETFs ETF Name
Index / Commodity Tracked
iShares S&P 500 USD S&P 500 Index iShares S&P 500 GBP S&P 500 Index iShares DJ Euro STOXX 50 DJ Euro STOXX 50 Index iShares FTSE 100 FTSE 100 Index Gold Bullion Securities Spot Gold Source: Barclays Global Investors, based on data as at 31 March 2009.
Market Capitalisation **AUM (£bn) 3.2 3.2 3.1 3.1 1.6
What are Exchange Traded Funds? (2) Low costs Low tracking error
Fund iShares FTSE 100 ETF Scottish Widows UK Tracker HSBC FTSE 100 Index M&S UK 100 Cos L&G UK 100 Index FTSE 100 Index
Size (m) 3,051 295 249 190 118
Total Expense Ratio 0.40 1.00 1.14 1.04 2.05
Five Year Performance 13.1 11.4 12.2 10.9 8.4
Deviation from index (annualised) 1.15 1.49 1.34 1.58 2.05
19.0
0.00
Five years to 08.05.09, total return with income reinvested net of basic rate tax. Source: Morningstar, Barclays iShares.
What are Exchange Traded Funds? (3) Structure:
•ETFs (Exchange Traded Funds): tradable shares in open-ended funds
•ETNs (Exchange Traded Notes): tradable secured zero-coupon notes
Background (1) – size of the market First introduced in the US in 1993 1,635 ETFs/ 2,857 listings on 43 exchanges worldwide Assets under management - $634bn Global net ETFs inflows in 2008: $266bn Q1 2009 average daily trading volume: $89bn
Data as at end of Q1 2009. Not including ETCs, ETNs. Source: BGI (Barclays Global Investors)
Background (2) - Range of asset classes Equities
Fixed Interest
Commodities
Money Market
single country
e.g.
US, China, Russia, Kuwait
region
e.g.
Europe, Asia Pacific, Emerging Markets
sectors
e.g.
banks, utilities, shipping
real estate
e.g.
EPRA Asia property
private equity
e.g.
S&P listed private equity
fundamentally weighted
e.g.
RAFI Japan
other
e.g.
Shariah
government bonds
e.g.
sterling, Emerging Markets
inflation linked bonds
e.g.
global, Europe
corporate bonds
e.g.
sterling, euro
diversified
e.g.
CRB Commodities index
energy
e.g.
crude oil, gasoline
base metals
e.g.
copper, zinc
precious metals
e.g.
gold, platinum
agricultural
e.g.
corn, live cattle
e.g.
USD, GBP
Comparison ETF v Open Ended v Closed-Ended v Future
Legal Structure
ETF/ETN Open-Ended Fund Open-ended traded fund/ zero OEIC, Unit Trust coupon note
Closed-Ended Fund Investment Trust, ClosedEnded Investment Company
Future Exchange Traded Derivative
Notional Investment
100%
100%
100%
Pricing Minimum investment (Based on UK equity exposure) Dividend payments
Market hours 1 share (£nominal)
Generally once a day 1 share (£nominal)
Market hours 1 share (£nominal)
Generally quarterly
Expiry
Generally quarterly via CREST Perpetual
Perpetual
Generally quarterly via CREST Usually Perpetual
Margin (e.g. c. 9% on FTSE contract) Continuous 1 contract (e.g. FTSE is c. £4,000 margin based on £44,000 exposure) Not paid but market reflects in contract price Usually Quarterly (roll impact)
Stamp duty
No
No
Yes for UK domiciled fund
No
Mechanics – how do ETFs work? (1)
y Hold underlying constituents of index being tracked
y Gain economic exposure to index / commodity via swaps
Mechanics – how do ETFs work? (2) Holding index constituents
Example: FTSE 100 ETF (primary market) Buy FTSE 100 constituents in the market in corresponding market weightings (or may already hold on their books) + deliver to ETF custodian
Cash
Investor (via broker)
Market Maker FTSE 100 ETF shares
Underlying holdings:
same as index
Return profile:
achieved by holding the underlying
ETF custodian Issue FTSE 100 ETF shares
Mechanics – how do ETFs work? (3) Exposure via swap Example: FTSE 100 ETF (primary market) Buy securities (can be completely different from the index underlying holdings) as agreed with swap counterparty and deliver to ETF custodian
Cash
Investor (via broker)
ETF custodian
Market Maker FTSE 100 ETF shares
the portfolio held at the custodian is the investors' collateral
Issue FTSE 100 ETF shares
flow of funds reflecting the difference between the returns of portfolio held at custodian and the index return
Swap counterparty
Underlying holdings: can be different from index Return profile:
achieved by swap with counterparty. The returns of the securities held are swapped for the return on the index
Example of balance sheets in Appendix 6
Mechanics – how do ETFs work? (4) Counterparty risk What is counterparty risk? The risk that the counterparty to a transaction is unable to fulfil their obligations What ETFs does it affect? Those employing swaps to achieve their return profiles and those involved in securities lending What is the extent of the risk? Depends on the structure: 100% of NAV, uncollateralised 10% of NAV, uncollateralised 0% of NAV, uncollateralised
Liquidity – Normal Market Size (1) Market Liquidity - Good Name
Index Tracked
db x-trackers Sterling Money Market db x-trackers US Dollar Money Market iShares FTSE 100 Gold Bullion Securities (USD) iShares $ Treasury Bond 1-3 yr
Sonia TR index Fed Funds Effective Rate TR Index FTSE 100 Index Spot Gold Barcap US Govt 1 To 3 Year TR
Market Capitalisation
Market Spread (bps)
Daily Volume £000
59 42 3,051 2,592 163
3 4 5 8 8
433 1,440 62,166 37,453 1,865
Market Liquidity - Poor Name Lyxor FTSE Coast Kuwait 40 USD Lyxor FTSE Coast Kuwait 40 GBP ETFS Russell Global Gold (GBP) ETFS Leveraged Tin ETFS Russell Global Gold (USD)
Index Tracked FTSE Coast Kuwait 40 Index FTSE Coast Kuwait 40 Index Russell Global Gold Index Dow Jones-AIG Tin Excess Return Index 2x Russell Global Gold Index
Market Capitalisation 11 11 8 1 8
Market Spread (bps) 305 302 270 244 243
Daily Volume £000 2.0 0.2 16.0 24.0 309.0
Source: Bloomberg. Market Spread (bps) = Avg Bid-Ask spread (spread as percentage of mid price) calculated as an average of snapshot bid-ask spreads taken every ten minutes between 10:06 – 16:26 GMT on 6 May 2009. Min and max spreads were taken during the same intervals..
Liquidity (2) – Normal Market Size
Liquidity (3) – Outsized orders Where spreads imply worse liquidity in underlying securities, outsized orders often dealt within screen prices Where spreads reflect liquidity in underlying securities, outsized orders often dealt outside screen prices iShare FTSE 100 – market orders of £1m to £4m not uncommon. Beyond this, investors can go OTC.
Costs (1) – Breakdown
Index Tracked FTSE 100 MSCI Emerging Market Small Cap
Explicit Costs Implicit Costs Revenue Generation Total Costs Total Expense Ratio Market Spread Rebalance costs Tracking error Stock Lending 40 10 10 2 -1 61 74 130 25 90 -10 309
Costs (2) –Implicit Market spread – For normal market size this is a function of typical trading volumes BUT For larger market size is a function of underlying liquidity Rebalancing costs – Market spreads incurred for transactions as a result of corporate actions and index changes.
Costs (3) – Implied by performance Total cost comparison based on performance ETF / Index (Estimated spread)
Performance (v FTSE 100 Index)
db-x trackers FTSE 100 (17bps) Lyxor ETF FTSE 100 (85bps) iShare FTSE 100 (5bps) FTSE 100 Index
-27.9% (-30bps) -28.0% (-40bps) -28.5% (-90bps) -27.6%
(Total return, based on longest common performance period on Bloomberg, 4/10/07 to 11/05/09. Mid to mid with income reinvested)
Investment strategies – using ETFs (1) Strategy
Example
Core – Satellite Strategy
iShares FTSE 100 + Actively managed funds / high conviction stocks
Eliminating cash drag
Seeking immediate equity exposure - decide which funds/stocks to buy later
Tactical asset allocation
Increase/reduce equity exposure
Pairs trading
Long Investment Trust on wide discount, Short Index ETF
Leverage
Leveraged ETFs
Short selling with limited liability
Short ETFs
Investment strategies – using ETFs (2) Leverage & Shorting Leveraged (2x) ETFs replicate twice the DAILY movement in the underlying. However, for holding periods > 1 day the leveraged ETF return can be different then the return of the index multiplied by 2. Short (-1x) ETFs replicate the inverse DAILY movement in the underlying. However, for holding periods > 1 day short ETF return can be significantly different from the inverse return of the index.
Investment strategies – using ETFs (3) Leveraged and Short ETFs: risk-return profile Low volatility
A
Index Daily change Cumulative change
Day 1 100
Day 2 101 1% 1%
Day 3 102 1% 2%
Day 4 103 1% 3%
Index
108
Leveraged (+2x)
Short (-1x)
106 104
Leveraged (+2x) Daily change Cumulative change
100
Short (-1x) A x(-1) Daily change Cumulative change
100
A x2
102 2% 2%
104 2% 4%
106 2% 6%
99 -1% -1%
98 -1% -2%
97 -1% -3%
Day 2 125 25% 25%
Day 3 90 -28% -10%
Day 4 103 14% 3%
150 50% 50%
66 -56% -34%
85 29% -15%
75 -25% -25%
96 28% -4%
82 -14% -18%
102 100 98 96 1
2
3
4
High volatility Day 1 100
A
Index Daily change Cumulative change
100
A x2
Leveraged (+2x) Daily change Cumulative change
Short (-1x) A x(-1) Daily change Cumulative change
100
Index
160
Leveraged (+2x)
Short (-1x)
140
120
100
80
60 1
2
3
4
Summary
Exchange Traded funds (ETFs) – listed, low cost trackers
ETF Landscape – grown to over $700bn in 15 years Comparison v other structures – real time trading, buy/sell @ NAV Mechanics – underlying replication or swaps Liquidity – ETF liquidity should reflect underlying liquidity Costs – explicit & implicit Investment strategies – increase/decrease exposure, shorting ETF Bulletin – weekly publication – data on every London listed ETF
Appendix 1:
Killik & Co ETF Bulletin TER (%)
**AUM (£m)
*avg bps spread
*min bps spread
*max bps spread
3m daily vol £000
YTD
Asia
0.65
950
62
54
86
64
-3.0
db x-trackers MSCI EM Asia
Asia
0.65
959
62
59
86
87
-3.2
USD
iShares DJ Asia/Pacific Select Dividend^
Asia Pacific
0.59
29
58
53
59
25
-12.4
GBP
iShares DJ Asia/Pacific Select Dividend^
Asia Pacific
0.59
28
59
31
60
60
-12.3
GBP
db x-trackers MSCI Asia Pacific ex-Jap
Asia Pacific ex-Jap
0.45
17
31
26
54
n/a
GBP
db x-trackers MSCI Pacific ex-Jap
Asia Pacific ex-Jap
0.45
56
56
27
89
n/a
EPIC
CCY
ETF Name
Category
XMAS
GBP
db x-trackers MSCI EM Asia
XMAD
USD
DAP APD XAXJ XPXJ SFE
GBP
iShares AC MSCI Far East ex Jap Small Cap
Asia Pacific ex-Jap
0.74
4
95
90
500
98
1.5
DFE
USD
iShares AC MSCI Far East ex Jap Small Cap
Asia Pacific ex-Jap
0.74
4
93
82
497
7
1.4
LASU
USD
Lyxor ETF MSCI AA Asia ex Japan
Asia Pacific ex-Jap
0.65
14
144
138
155
67
LASP
GBP
Lyxor ETF MSCI AA Asia ex Japan
Asia Pacific ex-Jap
0.65
8
141
139
144
49
-4.9
DBRC
USD
iShares FTSE BRIC 50
BRIC
0.74
86
65
54
499
71
5.3
BRIC
GBP
iShares FTSE BRIC 50
BRIC
0.74
86
59
26
496
448
LEEU
GBP
Lyxor ETF Eastern Europe
East Eur ex-Russia
0.50
4
114
113
117
1
-23.9
LEUU
USD
Lyxor ETF Eastern Europe
East Eur ex-Russia
0.50
n/a
106
105
112
30
-24.1
EER
GBP
iShares MSCI Eastern Europe
Eastern Europe
0.74
97
58
9
294
278
-4.0
5.4
Appendix 2:
London Listed ETFs Six ETF providers and over 400 listings ETF provider
Offering mainly:
iShares
equities and fixed interest
db x-trackers
equities
Lyxor ETF
equities
Invesco PowerShares
fundamentally weighted equity indices
SPA ETF
fundamentally weighted equity indices
ETF Securities
commodities, regional and sectorial equity indices
Appendix 3:
Full Comparison Legal Structure
ETF/ETN Open-Ended Fund Open-ended traded fund/ zero OEIC, Unit Trust coupon note
Closed-Ended Fund Investment Trust, ClosedEnded Investment Company
Holding cost Notional Investment
Total Expense Ratio (TER) 100%
Total Expense Ratio (TER) 100%
Total Expense Ratio (TER) 100%
Purchase/sale costs
Brokerage fees
Minimum investment (Based on UK equity exposure) Dividend payments
1 share (£nominal)
Initial/exit charges; Brokerage Brokerage fees; fees Stamp duty 1 share (£nominal) 1 share (£nominal)
Counterparty exposure Pricing Market Liquidity
Future Exchange Traded Derivative
Contract roll costs Margin (e.g. c. 9% on FTSE contract) Can range from 0-100% Can range from 0-10% Can exist None Market hours Generally once a day Market hours Continuous Should be same as liquidity of N/A - dealing directly with the Dependant on supply/demand High - dependant on underlying fund manager for the fund's shares supply/demand
Expiry
Generally quarterly via CREST Perpetual
Management fee UK Distributor Status ISA/SIPP Stamp duty
Yes (small: 20-98bps) Generally yes Generally yes No
Perpetual
Generally quarterly via CREST Usually Perpetual
Initial/variation margin payments, rollover costs 1 contract (e.g. FTSE is c. £4,000 margin based on £44,000 exposure) Not paid but market reflects in contract price Usually Quarterly (roll impact)
Yes (c 1.5%) Generally yes Generally yes No
Yes (0.5% - 2%) Generally yes Generally yes Yes for UK domiciled fund
No No No No
Generally quarterly
Appendix 4:
Swap v holding underlying Why use a swap? Minimise tracking error How is the tracking error minimised? The return is generated via a contract promising the index returns What are the risks? Counterparty risk What happens if the counterparty defaults? The level of the loss depends on the counterparty exposure and level (if any) of collateralisation.
Appendix 5:
When counterparty risk hits home: AIG AIG was one of the world’s largest insurance companies. AIG was the counterparty for ETF Securities’ Commodities Platform. In September 2008, following its credit rating being downgraded, the market feared it may default on its financial obligations. Market makers stopped making prices in the ETNs backed by AIG. Even though the Fed announced a $85bn bailout for AIG a day later, it approximately a week for trading in these ETNs to normalise. ETF Securities has aimed to address this weakness by arranging for AIG to post collateral for its obligations.
Appendix 6:
db x-trackers FTSE 100 balance sheet
Appendix 7:
Gold Long/Leveraged/Short return comparison
Appendix 8:
Oil Long/Leveraged/Short return comparison
Appendix 9:
Conventional Indices v Fundamental Indices Conventional - Based on market capitalisation. e.g. FTSE 100, S&P 500, Eurostoxx 50. Issuers – iShares, ETFS, db x-trackers, Lyxor
Fundamental – Based on valuation metrics. e.g. Market Grader – Filters US equities based on 24 factors from four categories; growth, value, profitability, cashflow. Issuers – SPA ETF (MarketGrader), Invesco PowerShares (Research Affiliates)
Appendix 10:
Conventional Indices v Fundamental Indices
Fees - average TER 0.5% (conventional) v 0.8% (fundamental)
Liquidity – median Bid/Offer spreads – both c56bps Performance – Outperforming to mid ’07, underperforming since
Appendix 9:
Risks associated with ETFs Risks Usual risks associated with capital market investments. You can lose the value of your investment. Tracking error can be high Bid-ask spreads can be wide Short/Leveraged ETF returns can vary widely from expectations Swap counterparties can default The implicit cost of rolling futures contracts can be high Long term underperformance of index due to fees This is not an exhaustive list of risks associated with investing in ETFs
This document has been issued by Killik & Co on the basis of publicly available information, internally developed data and other sources believed to be reliable. Any view or recommendation is based entirely on such data as we have no other interest or conflict of interest with companies covered. Partners or employees of Killik & Co may have a position or holding in any of the above investments or in a related investment. The value of investments and the income from them may vary and you may realise less than the sum invested. In the case of higher volatility investments, these may be subject to sudden and large falls in value and you may realise a large loss equal to the amount invested. Some investments are not readily realisable and investors may have difficulty in selling or realising the investment or obtaining reliable information on the value or risks associated with the investment. Where a security is denominated in a currency other than sterling, changes in exchange rates may have an adverse effect on the value of the security and the income thereon. In addition, if the security is listed outside the United Kingdom, the listing regime and local regulation may differ from that which pertains in the United Kingdom. This may affect the degree of protection that consumers receive. The past performance of investments is not a guide to future performance. The investment or investment service may not be suitable for all recipients of this publication and any doubts regarding this should be addressed to your broker.
Killik & Co is a trading name of Killik & Co LLP, a limited liability partnership authorised and regulated by the Financial Services Authority and a member of the London Stock Exchange. Registered in England and Wales No. OC325132 Registered office: 46 Grosvenor Street, London W1K 3HN. A list of Partners and branch offices is available upon request. To telephone all offices please call 020 7337 0400 or see the website at www.killik.com
4:00pm
Wealth Peer Group meeting (Music Room)
4:45pm
ETFs explained – Mick Gilligan, Killik & Co (Music Room)
5:45pm
Champagne Reception (Paul’s Terrace) with Fine Violin Fund presentation – Florian Leonhard
6:30pm
Evening buffet (Music Room)
7:15pm
Cash Management presentations (Music Room) Toby Allebon, Investec – Investec High 5 Deposit Henry Buckmaster – Prime Rate AAA rated Money Market Fund Ulf Blacher, ZAN Partners Tri-Party Repo Exchange (T-REx)
8:15pm
Sweets and coffee (Music Room)
9:00pm
Close