As market participants large and small continue to embrace ETF trading, understanding the dynamics of this market has never been more important. How can firms leverage the unique characteristics of this fund class in an effort to achieve the best possible trading results?
On CAPIS’ recent virtual panel, we hosted industry experts for an in-depth discussion on the ins and outs of the ETF trading process. We welcomed three senior leaders from the ETF space:
- Steve Sachs, COO at Goldman Sachs ETF Accelerator
- Patrick Nolan, Director of Investment Strategy at First Citizens Bank
- Chad Muller, Senior Equity Trader at CAPIS
Couldn’t join us? Here are a few of the key takeaways from the discussion.
A Shifting Investment Landscape
The discussion began with an acknowledgement of the industry’s transition away from traditional mutual funds and toward ETFs (which now comprise roughly 65% of core investment strategies).
Nolan offered his perspective as an asset allocator closely involved in selecting and utilizing funds within client portfolios. “I think we have to separate the notion of the packaging of an ETF with the strategy of indexing,” he stated. He emphasized the numerous benefits that ETFs offer to end investors – lower costs, favorable expense ratios, and greater tax efficiency – and predicted these factors will continue to drive adoption, particularly as the industry evolves to offer a wider range of exposures.
Portfolio Construction: Key Considerations
The US is experiencing a proliferation of active ETFs, which now comprise two-thirds of new ETF launches in the past four years, totaling 25% of total AUM flow. Sachs and Muller discussed key considerations in building ETF portfolios and what firms are looking for from a selection perspective.
Sachs emphasized the importance of educating investors on ETF mechanics – in particular, the creation-redemption process and its relationship to liquidity. “The one thing that I always leave everybody with is…every ETF is as liquid as its underlying basket of security,” he said.
Chad outlined CAPIS’ unique approach to trading large ETF blocks, which is made possible by our agency model. We leverage relationships with authorized participants (APs) to secure competitive two-sided quotes, helping us provide clients with the best possible price. “We’re able to move very large notional without affecting the marketplace, which is unusual compared to traditional equities,” he stated.
Chad also discussed the nuances of VWAP trading, cautioning against strict adherence to this method. Instead, he suggested listeners involve APs for a higher chance of achieving streamlined execution and tight pricing alignment.
Navigating ETF Portfolio Rebalancing
As industry players look to implement fulsome asset allocation models using multiple ETFs, how should traders think about rebalancing trades across an entire portfolio? Muller provided a sense of how CAPIS accomplishes it.
“First, we take the basket and put it in the basket model,” he said. “If we’re relatively close to being in line, we’re going to get you to a dollar-neutral point and start working the order for you.” CAPIS utilizes dark pools to capture the midpoint, passive algorithms, and, for illiquid names, two-sided quotes via APs. This method helps ensure dollar neutrality is maintained throughout the process, “coming in within a couple of basis points from where [clients] started,” Muller stated.
Addressing Misconceptions in the ETF Market
When onboarding clients for a new asset class or strategy, misconceptions are bound to arise. The panelists spoke about some of the top misunderstandings they’ve encountered when speaking with clients and prospects on the ETF space.
Steve emphasized the importance of client education. “As Goldman has transitioned to indexation across strategies, I’ve spent a lot of time with our client-facing personnel to ensure that clients are aware that every dollar in the portfolios we manage pursues excess returns,” he stated. He also explained how he has combatted the false assumption that indexing equates to low-cost market exposure with no additional benefit. He pointed to the value of tactical asset allocation, factor exposures, and active managers who can deploy their unique knowledge and advantages within certain asset classes. All three of these levers can be deployed across the portfolio construction process to help yield optimal results.
Emerging Topics: T+1 and Bitcoin ETF Approval
To wrap up the discussion, all three panelists offered their perspectives on some trending industry topics and their potential implications for the ETF landscape.
While the rapidly approaching T+1 settlement deadline has left many firms scrambling to accelerate their post-trade processes, Sachs and Muller explained that this is essentially a non-event for ETF trading, as the vast majority of ETF transactions already settle on a T+1 basis.
The SEC’s recent regulatory approval of spot Bitcoin ETFs was the other major topic the panelists cited. Nolan offered his perspective on the move, stating that securing safe exposure in client portfolios is a major concern for banks. “The advent of the ETF wrapper and the added regulatory environment that surrounds that wrapper in the US makes us a bit more comfortable,” he stated. Muller highlighted that CAPIS has received many inquiries regarding Bitcoin ETF strategies, and that we are maintaining a close watch of the volatility of the underlying asset class amid evolving regulations.
Interested in learning more about ETF trading? Reach out to the CAPIS team today to start a conversation.
