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How ETFs Can Add Value In An Institutional Portfolio
Quantitative | Australia
Event:
• Despite exchange traded funds becoming a key element in institutional
portfolio management offshore, they have yet to be widely adopted by
domestic managers (ASX ETF volumes account for ~0.5% of equity
turnover whereas in the US the figure is typically 20-30%).
• Vanguard's decision this week to cut the management fee on its ASX
300 ETF to 15bp (was 27bp) might provide a strong catalyst for
institutional investors to revisit ASX-listed ETFs. Further, its decision to
launch a Small Cap ETF and price it at 30bp (a 40% discount to the
existing products) could generate significant interest in a market that
lacks a liquid vehicle for managing small cap exposure.
• Given the lack of institutional usage of ETFs in the Australian market, we
have taken the opportunity to compare them to the more commonly
used equity products (futures, swaps & options), highlighting how they
can be a valuable tool in efficiently managing institutional portfolios.
Key differences between ETFs and 'One-Delta' alternatives:
• Institutions can access the Liquidity of both the ETF and its
Underliers: With high liquidity, trading costs can be lower in an ETF
than they are in the physical market.
• ETFs are more Tax Effective than the Alternatives: Holding futures
forgoes ~110bp p.a. of franking. Long-term gains on ETFs will attract
CGT discounting.
• Securities Lending Revenues can Improve Returns: Hedge funds
implement ~20% of their shorts via ETFs. A high level of demand for
ETF borrow means that lending revenues can more than offset MERs.
• ETFs provide the only listed sector, size and style exposures: The
main US Small Cap ETF is the 2nd most actively traded security on the
NYSE and attracts a high level of short interest. We believe that there
should be strong demand for a similar ASX product given the abundance
of specialised small cap mandates and the lack of listed small cap
hedges. We estimate underlying liquidity in the ASX Small Cap ETFs of
~$150-200m/day and strong demand for stock borrow.
The advantages of ETFs suggest a wide range of applications:
• Cash Equitisation: ETFs may outperform both futures and physicals on
an after-tax basis when the demand for ETF borrow is high.
• Tactical Asset Allocation: Quick, efficient implementation of a shortterm
trading view.
• Transition Management: ETFs can be a useful vehicle for maintaining
market exposure during prolonged transitions. Taking receipt of the
underlying ETF basket can help reduce transaction costs.
• Portfolio Completion / Overlay: Management of risk limits on
market, sector and size exposures of a multi-manager portfolio.
• While ETFs provide many useful applications in an institutional setting,
their low-cost structure provides an obvious competitive threat to active
managers. Countering this, however, is the fact that as more assets
flow from active to passive, the more skilled managers are likely
to face a less informed market, making their task of generating
outperformance much simpler in the long run.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
How ETFs Can Add Value In An Institutional Portfolio
Quantitative | Australia
Event:
• Despite exchange traded funds becoming a key element in institutional
portfolio management offshore, they have yet to be widely adopted by
domestic managers (ASX ETF volumes account for ~0.5% of equity
turnover whereas in the US the figure is typically 20-30%).
• Vanguard's decision this week to cut the management fee on its ASX
300 ETF to 15bp (was 27bp) might provide a strong catalyst for
institutional investors to revisit ASX-listed ETFs. Further, its decision to
launch a Small Cap ETF and price it at 30bp (a 40% discount to the
existing products) could generate significant interest in a market that
lacks a liquid vehicle for managing small cap exposure.
• Given the lack of institutional usage of ETFs in the Australian market, we
have taken the opportunity to compare them to the more commonly
used equity products (futures, swaps & options), highlighting how they
can be a valuable tool in efficiently managing institutional portfolios.
Key differences between ETFs and 'One-Delta' alternatives:
• Institutions can access the Liquidity of both the ETF and its
Underliers: With high liquidity, trading costs can be lower in an ETF
than they are in the physical market.
• ETFs are more Tax Effective than the Alternatives: Holding futures
forgoes ~110bp p.a. of franking. Long-term gains on ETFs will attract
CGT discounting.
• Securities Lending Revenues can Improve Returns: Hedge funds
implement ~20% of their shorts via ETFs. A high level of demand for
ETF borrow means that lending revenues can more than offset MERs.
• ETFs provide the only listed sector, size and style exposures: The
main US Small Cap ETF is the 2nd most actively traded security on the
NYSE and attracts a high level of short interest. We believe that there
should be strong demand for a similar ASX product given the abundance
of specialised small cap mandates and the lack of listed small cap
hedges. We estimate underlying liquidity in the ASX Small Cap ETFs of
~$150-200m/day and strong demand for stock borrow.
The advantages of ETFs suggest a wide range of applications:
• Cash Equitisation: ETFs may outperform both futures and physicals on
an after-tax basis when the demand for ETF borrow is high.
• Tactical Asset Allocation: Quick, efficient implementation of a shortterm
trading view.
• Transition Management: ETFs can be a useful vehicle for maintaining
market exposure during prolonged transitions. Taking receipt of the
underlying ETF basket can help reduce transaction costs.
• Portfolio Completion / Overlay: Management of risk limits on
market, sector and size exposures of a multi-manager portfolio.
• While ETFs provide many useful applications in an institutional setting,
their low-cost structure provides an obvious competitive threat to active
managers. Countering this, however, is the fact that as more assets
flow from active to passive, the more skilled managers are likely
to face a less informed market, making their task of generating
outperformance much simpler in the long run.
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