Category archive: Week 6 2012

Institutions Turn To Leveraged And Inverse ETFs

(LONDON) Leveraged and inverse exchange traded funds are seen as the bad boys of the ETF world, criticised for delivering unexpected results and blamed for exacerbating market volatility. However, interest among institutional investors is growing, according to the FT’s February ETF special. 

The second most heavily traded ETF in Europe last year was an inverse Dax product run by Deutsche Bank while the seventh most traded US ETF in 2011 was the Direxion daily financials 3x bull. Leveraged and inverse ETFs are also known as “non-delta one” products because they deliver a multiplied return of an underlying benchmark. “It is clear that non-delta one products are becoming more popular with a growing range of clients,” says Nizam Hamid, head of ETF strategy at Lyxor. Lyxor’s estimates suggest non-delta one products gathered around €504m in inflows last year, taking assets to €5.2bn, so they hold only a small share (2.3 per cent) of total European ETF industry assets. But Mr Hamid highlights rising trading volumes as evidence of their growing popularity with turnover up 13 per cent to €116bn in 2011.

Lyxor has seen growing interest in non-delta one products from smaller institutions and sophisticated retail clients. These investors, says Mr Hamid, are often more comfortable with leveraged and inverse ETFs as these are cash products whereas futures involved managing margin requirements and other operational challenges. “ETFs provide a range of options for investors who want to go short. They can use an inverse product but clearly must be aware of the impact of daily resetting, or they can borrow a conventional “long” ETF and then sell it in the market to express a short position. “That can make more sense if a client wants to run a short position for an extended period as it avoids any issues with the daily resetting of inverse products.”

Historically, interest in non-delta one products increases in times of high market volatility. Lyxor estimates that these products accounted for an average of 17 per cent of on-exchange ETF trading in Europe last year but this rose to 20 per cent in August and peaked at 23 per cent in September amid widespread concerns about the eurozone debt crisis and elevated US stock market volatility. Mr Hamid says there was a clear shift in non-delta one usage last year into single country products linked to Germany, France and Italy and away from pan-European exposures. He also highlights an emerging interest in using non-delta one products in bond markets, although from a very low starting point.

Danny Dolan, managing director, structured funds at RBS, says a number of eurozone clients, particularly larger private banks, bought the bank’s monthly inverse leveraged ETFs in the volatile market conditions of the third and fourth quarter. “The interest was entirely driven by risk management rather than speculation about any downward moves in the market, with institutional clients who wanted to keep their existing portfolios in place using RBS’s monthly inverse leveraged ETFs as hedging tools.” Mr Dolan says RBS has also seen investors who are convinced market bears using leveraged ETFs if they expect a short-term rally while still maintaining their negative long-term view. In the US, new inflows into non-delta one products more than doubled to $11bn last year but assets rose only slightly to $32bn (just 3 per cent of total US ETF assets).

Volatility played a key role in driving up inflows

Steve Cohen, managing director at ProShare Advisors, says many investors are not content to close their eyes and ride out price swings. “Many knowledgeable investors want more control to mitigate price swings and volatility. For example, baby boomers approaching retirement don’t have 10 or 20 years to wait to recover from losses.” Mr Cohen says the range of investors using leveraged ETFs is broad and diverse, including pension funds, endowments, mutual fund managers, financial advisers and knowledgeable individual investors. These investors find leveraged ETFs to be sound risk management tools to help hedge existing exposures against damaging price swings or to pursue opportunities presented by market volatility. “They are all investors who are engaged in managing their portfolios.

Many use leveraged ETFs to manage risk, though some also look for ways these funds can bolster returns.” To illustrate, Mr Cohen points to the ProShares UltraShort 20+ Year Treasury ETF, known as TBT, designed to appeal to investors who expected a price fall for long-dated government bonds. TBT attracted net inflows of more than $1bn in 2011, even though its underlying index had total returns of about 34 per cent last year. Mr Cohen says investor interest in TBT reflects concerns that long-term bond yields will rise and demonstrates investors’ desire to manage risk in their fixed income exposures. ProShares recently launched two new ETFs that allow investors to express their views on whether long-date inflation expectations will rise or fall, reflecting the spread between 30-year US Treasuries and 30-year US Tips.

Yields on long-dated Treasuries have dropped below yields on Tips of the same maturities, partly as a result of the Federal Reserve’s intervention in the market via Operation Twist. But this divergence has led some investors to question whether they are being adequately compensated for the risk that inflation could rise in the future. “Many investors do not realise that Tips have interest rate risk and they could be sitting on potential losses if rates rise,” says Mr Cohen.

DB Launched Roll-Optimized ETC

(FRANKFURT) A new exchange traded commodity issued by db ETC Index plc has been tradable on Xetra since Friday. The new fund called “db Metals & Energy Booster ETC (EUR)” tracks the performance of the db Metals and Energy Booster Euro Unhedged Index.

The index comprises 13 commodities from the precious and industrial metals and energy sectors. The approach is fundamentally based on a roll-optimised mechanism with periodic replacement of the commodity futures tracked in the commodities index. All db ETCs are backed by physically deposited gold bars. Deutsche Börse’s ETC segment product range currently comprises 235 instruments. The monthly trading volume of ETCs on Xetra averages over €900 million.

Two New UBS ETFs Tradable On Xetra

(FRANKFURT) UBS issued two new ETFs within Deutsche Börse’s XTF segment – both linked to US infrastructure companies. The first ETF is called “UBS ETF MSCI USA Infrastructure (USD) I”, the second one “UBS ETF MSCI USA Infrastructure (USD) A”.

The two new ETFs are based on the same reference index, the MSCI USA Infrastructure Index. The two UBS ETFs differ according to asset class, with asset class I ETFs primarily aimed at institutional investors. The “I-Class” ETF has a TER of 0.48%, while the “A-Class” charges 0.68%. The ETFs on the MSCI USA Infrastructure Index enable investors to track the performance of American companies from the infrastructure sector.

Increased Desire For Tailor-Made Indices

(LONDON) Most money in ETFs tracks mainstream indices from one of the major index providers, such as FTSE, Dow Jones, Standard & Poor’s or MSCI. These indices are familiar products, understood even by not very sophisticated investors and reported on the news as indicators of the overall stock market.  Recently, however, as the range of ETFs proliferates, apparently unstoppably, some ETF providers are finding the range of indices available is not sufficient. Some are asking the index providers to help them develop new indices, either to gain exposure to markets that are not already well covered or to use a new methodology that might outperform a traditional index. The FT wrote-up the following market wrap:

“There might be a situation where they’re trying to create a certain return to investors in a passive form,” says Michael John Lytle, director of marketing at Source. Source’s main contribution to index innovation has been in the form of its sector ETFs, covering European equity sectors with indices specially designed to ensure they are suitable for shorting, addressing issues such as concentration, diversification, liquidity and the availability of stocks to borrow. Others will develop their own proprietary indices, perhaps relying on the index team of a parent investment bank.

In the US, a number of ETF providers have applied to the Securities and Exchange Commission for permission to act as their own index providers. In Europe, the Ucits framework allows for a company to use a proprietary index, subject to large amounts of documentation to show all conflicts of interest have been considered and dealt with.  The difference shows up in the ETF prospectus, according to Manooj Mistry, head of db x-trackers UK, a Deutsche Bank subsidiary. The description of a normal third-party index takes up perhaps half a page. Inhouse indices require pages and pages of description, including the details of the methodology as well as explanations of why it is the most suitable index.

Concerns that an inhouse index might prove more expensive than one provided by a specialist provider are ill-founded, says Mr Mistry. Despite the economies of scale one might expect a large index proprietor might benefit from, the price of licensing a mainstream index is not substantially different from that of using one developed by Deutsche Bank’s own index research team. In the US, ETF provider Wisdom Tree has proprietary indices at the heart of its model. Based on a concept developed by Jeremy Siegel, professor of finance at the Wharton School of the University of Pennsylvania, Wisdom Tree’s indices are dividend weighted – akin to the concept of fundamentally weighted indices, where each stock’s weight in an index is determined not by its size but by some metric supposed to indicate its financial health or prospects.

Some commentators are concerned that proprietary indices can lead to conflicts of interest that are difficult to justify. “I believe index providers must remain independent from ETF providers to avoid any conflict of interest,” says Valerie Baudson, managing director of Amundi ETF. “Nonetheless, it is in the investors’ best interests that ETF providers ask index providers to work on new products when they register strong market demand for them.” Not all ETFs based on customised indices are the brainchild of the ETF provider alone. Ideas often come from other sources, such as investors, index providers and investment banks. For example, Source recently launched the LGIM Commodity Composite Source ETF, based on Legal & General Investment Management’s own index, effectively an index of indices.

While it is easy to come up with new index ideas, the challenge is to convince a fund manager it is worth launching an index based on that idea. “There are lots and lots of indices popping up all the time,” says Mr Lytle. “It’s extremely time-consuming to analyse whether they add value.” In other words, it may not be worthwhile developing a new index because it may not fill a need or add anything previously unavailable to an investment portfolio.

Source is invited to consider as many as 20 index ideas for every one it ends up using, according to Mr Lytle. It is worth spending some time analysing this plethora of potential product, however, because finding a truly distinctive index can be a big advantage in the crowded ETF market. “If you can tap into something that is not being provided by existing indices, you can tap into a trend and direct flows into your products,” points out Mr Lytle.

BNY Mellon Won New ETF Mandate

(NEW YORK CITY) BNY Mellon recently won the servicing mandate (including custody, fund accounting and fund administration) for the AdvisorShares Rockledge SectorSAM ETF (SSAM). This mandate expands BNY Mellon’s relationship with AdvisorShares, which began in 2009, to include 12 ETFs with assets totaling more than $420 million.

Sub-advised by Rockledge Advisors LLC, the new ETF seeks to generate stable and consistent annual returns under all market conditions by investing in both long and short positions in U.S. sector ETFs that offer exposure to U.S. large capitalization equities.  The ETF employs an actively managed and diversified equity sector rotation process based on a proprietary quantitative analysis known as the “Sector Scoring and Allocation Methodology.” Utilizing this analysis, the fund managers will buy long the sector ETFs that Rockledge forecasts to outperform the S&P 500 Index while also selling short an equal dollar amount of sector ETFs that are expected to underperform the S&P 500. The fund expects to hold equal amounts long and short, creating a dollar neutral portfolio.

“We expanded our relationship with BNY Mellon because of its ability to provide comprehensive support for alternative ETFs,” said Noah Hamman, founder and chief executive officer of AdvisorShares.  “This new fund requires BNY Mellon to support our ability to take both long and short positions.” “We continue to see an increasing array of ETF strategies being developed by our clients, including actively managed funds such as those created by AdvisorShares,” said Joseph Keenan, managing director and global head of exchange-traded fund services at BNY Mellon Asset Servicing.  “BNY Mellon remains committed to the ongoing enhancement of its industry-leading ETF technology platform to facilitate the rapid evolution of the ETF business.”

US ETF Trading Volumes Fall To Historic Lows

Are ETFs The Cause For Market Volatility?

(IRVINE, CA) Exchange traded funds have been accused of being the reason for some of the wild market swings that occur. Are these funds the real culprit behind market volatility? ETFs have gained popularity over the years, due to their diversification benefits and low cost. The flexibility to trade a basket of stocks throughout the day is enticing for many. According to Investment Company Institute data, there are more than 1,110 ETFs trading in the U.S., up from about 200 that traded in 2005, reports Scott Cendrowski for CNN Money. Furthermore, ETFs now account for 30% of trading volume on U.S. exchanges.

“As these products have increased, correlations have been increasing every year,” Harold Bradley, chief investment officer of Ewing Marion Kauffman Foundation, said.  However, there is no hard evidence that ETFs are the cause for market volatility. ETFs are an easy case to take the blame because they are relatively new on the scene, but much of the ETF trading that takes place never results in the actual buying and selling of the funds’ underlying stocks, says Morningstar. The actual basket of shares are trading but the contents, or stocks within, don’t actually trade.

Read the full article here.

The 50 Mutual Funds With Facebook Stakes

(NEW YORK CITY) In a recent note, Morningstar research found that 50 mutual funds have stakes in either the A class or B class of Facebook. Among the largest holders are T. Rowe Price, Fidelity Investments and Morgan Stanley.

Morgan Stanley also is the lead underwriter in the offering, which is expected to raise at least $5 billion and possibly as much as $10 billion. The amount set out in the company’s filing of intent to offer shares said $5 billion, but that is not a fixed amount. Morgan Stanley “may see the biggest boost among the three because Facebook shares in its funds constitute the largest percentage of assets among the 50 offerings, around 3% or so,’’ Morningstart said.

Download the full list here.

How Global Are The New iShares Commodity Producer ETFs?

(SAN FRANCISCO) BlackRock lauched five iShares ETFs focused on large-cap commodity producers. The new global equity-based funds, which are traded on the NYSE Arca, offer access to commodity producers. According to iShares’ press release, the series includes “the first equities-based solution to express a view on global energy prices”. Some experts questioned this expression, as competitor funds like the SPDR S&P International Energy Sector ETF (IPW) are highly correlated with the new iShares FILL. Also, some of the iShares ETFs are exposed up to 50% to US Large Caps of each sector (i.e. VEGI). Nevertheless, a benefit of these new ETFs is the basic approach of having products which are exposed to a diversified range of companies from all over the world – of course, within the same industry.

The five new funds includes:

• iShares MSCI Global Agriculture Producers Fund (NYSEArca: VEGI),
• iShares MSCI Global Energy Producers Fund (NYSEArca: FILL),
• iShares MSCI Global Select Metals & Mining Producers Fund (NYSEArca: PICK),
• iShares MSCI Global Gold Miners Fund (NYSEArca: RING)and the
• iShares MSCI Global Silver Miners Fund (NYSEArca: SLVP).

“Commodity producer ETFs are a unique way for investors to access equity-based exposure to this asset class, wrapped with the diversification benefits of an ETF.”said Darek Wojnar, Head of US iShares Product Development and Management at BlackRock in the press statement.

According to iShares, the commodity producing ETFs include only companies at, or near, the initial phase of production of the commodity. For example, investors looking to express a view on global food prices can use the Global Agriculture Producers Fund to target the front end of the production chain (fertilizers or agricultural materials) while excluding exposure from companies at the end of the production chain (packaging and marketing). Companies at the beginning of the production cycle are more sensitive to fluctuations in the underlying commodity price, whereas companies further down the production cycle are impacted by a number of factors in addition to commodity prices.