Tag Archives: ari weinberg


SEC Aims To Ban Geared ETFs

The US SEC apparently has its cross-hairs on so-called ‘geared ETFs,’  those high-testosterone, levered instruments that incorporate derivatives so as to deliver an advertised 2x or 3x return for certain strategies versus a typical 1:1 correlation provided by plain vanilla exchange-traded funds.  The SEC proposal would effectively ban the use of those products altogether.

As reported by Ari Weinberg in his most recent column in Pensions & Investments,  SEC staffers are holding further rounds of reviews of proposed rule changes that could effectively eliminate triple-leveraged and triple-inverse ETFs, which totaled 66 funds and $11.3 billion in assets under management as of Jan. 15, according to research firm XTF. Excluding exchange-traded notes, which are not subject to the Investment Company Act, the entire leveraged and inverse ETF universe includes 195 funds and $30.1 billion in assets.

This is not to suggest that  ‘inverse return’ exchange-traded funds are bad (even if many are actually completely unsuitable for most investors),  it’s just that nobody at the SEC seems to understand how they work, despite the fact these products need first be approved by the SEC before they can be issued, and despite the fact the SEC has given its green light to the these derivative-powered exchange-traded notes aka ETNs since they were first conceived and popularized  nearly 15 years ago.  According to one senior investment manager executive  overseeing nearly $10bil AUM and who asked not to be identified in this article, “..The proposed rules being discussed now simply proves that the SEC need not ever understand a financial product before they rubber-stamp the issuance of a financial instrument that would fall under SEC oversight.” He further added, “Its hard to say which is more broken, the SEC or products they allow to be sold to institutional and retail investors.”

“The SEC is responding to a combination of concerns, some of which are well founded and some of which are less well founded. There’s a belief that ETFs create risk because of asset class exposures, high trading volumes and market structure issues,” says Edward Baer, counsel at Ropes & Gray in San Francisco, who recently served as chief legal officer for BlackRock (BLK) Inc. (BLK)’s iShares business.

Geared ETFs, offered separately by ProShares and Direxion Investments, are designed to track two or three times the daily return (or inverse) of an underlying index. Awareness of the products peaked during the volatile days of the financial crisis, but both FINRA and the SEC have repeatedly voiced concerns that the products are misunderstood by many investors or used improperly.

As noted in the P&I story by Ari Weinberg..

In turn, both the SEC and FINRA have stated that regulatory examinations in 2016 will focus on the knock-on effects and risks to authorized participants in the ETF ecosystem. This network of investment banks and trading firms greases the wheels of ETF trading by creating or redeeming shares in the primary market and buying or selling in the secondary market. Their trading is motivated by the profit potential in arbitraging away price discrepancies in the ETF share price and the underlying assets.

“AP activities may … result in pressure on the financial integrity of broker-dealers in some conditions and this, in turn, could impair the liquidity provision function the broker-dealer plays when acting as an AP,” FINRA wrote in its annual examination priorities letter.

Similarly, the SEC’s office of compliance inspections and examinations said that it would focus on ETF compliance with their exemptive relief, as well as sales, trading, and disclosures involving ETFs.

For the full story from P&I, click here



Junk Bond ETFs-The Liquidity Debate Goes to SEC

MarketsMuse ETF and Fixed Income curators have frequently spotlighted the ongoing debates as to whether corporate bond ETFs, and in particular, junk bond-specific exchange-traded-funds pose special risks. Some argue that a liquidity crisis could unravel the high yield bond sector if/when institutional investors decide that risk of recession continues to ratchet higher, leading all of those investors to run for the exit at the same time, and in turn, causing a reverberation across the ETF market. The counter side to that thesis is that corporate bond ETFs (NYSE:HYG among them) are insulated from the risk of a catastrophe that might envelope the underlying components (the actual bonds themselves). One thing that is certain is that the US SEC is not certain, and they’ve raised the volume on this topic.

Adding light to this topic is WSJ columnist Ari Weinberg, someone who is arguably one of the best educated members of the 4th Estate when it comes to ETFs, and Monday night column deserves our kudos and sharing select extracts…Roll the tape..

junk-bond-etf-liquidity-crisisMost investors in mutual funds and exchange-traded funds probably don’t worry much about liquidity. After all, fund shares can be bought and sold easily anytime online, and trades are completed in one to three business days.

But there is another layer of trading—the trading the funds themselves do when a wave of selling by investors requires the funds to sell some of their assets—that has the Securities and Exchange Commission worried about liquidity. And the commission wants investors to be more aware of the risks it sees.

The issue is particularly pertinent for the fixed-income fund market, because assets that some of those funds hold are very thinly traded. Here’s a look at what’s involved.

Deciding between the two isn’t always straightforward. Here’s help clarifying the differences and similarities.

The SEC’s concern is that some mutual funds and ETFs might hold too many securities that aren’t easy to sell quickly. As a result, the funds might not always be able to adjust their holdings without “materially affecting” the funds’ net asset value per share, the commission said in its September announcement of proposed new liquidity-risk management rules. In other words, selling a substantial amount of illiquid securities quickly could drive down their price, resulting in a big loss for a fund, lowering its value.

Among other things, the proposed rules would require funds to categorize the liquidity risk of their holdings according to how many days it would take to sell the assets without greatly affecting their market price, and disclose those risk assessments to investors. The SEC also proposed to strengthen and clarify an existing guideline that no more than 15% of a fund’s assets should be held in securities that would take more than seven days to convert to cash.

Several ETF issuers, as well as the Investment Company Institute, a fund industry trade group, have said in comment letters that the SEC’s proposals aren’t relevant to most ETFs, because the funds are structured differently from mutual funds.

Mutual-fund investors buy and sell their shares directly from or to the fund. So mutual funds regularly need to sell assets on the open market to pay investors who are redeeming their shares. But ETF shares are traded among investors, not between investors and the fund. So most ETFs usually don’t have to sell assets when investors sell their shares, because the shares are being bought by other investors, not being redeemed by the fund.

ETF shares are only created or redeemed, and the underlying assets bought or sold, when doing so is necessary to keep the market price in line with the net asset value of the fund’s holdings. Those transactions are done between the funds and financial institutions called authorized participants, or APs, which often also serve as market makers in the ETFs and other securities.

Here is how it works in most cases: If heavy selling is driving an ETF’s market price below the fund’s net asset value, a market maker, acting through an AP or acting as an AP itself, will buy up shares and deliver them to the fund in the form of a so-called creation unit—taking them off the market—in return for an equal value of the underlying assets held by the fund. It’s then up to the trading firm to decide if it wants to hold those assets or sell them.

The argument ETF issuers are making to the SEC is essentially that this process insulates ETF investors from the dangers of a fund having to sell illiquid securities on the open market.

The opposing argument, made by the SEC and those who favor the proposed new rules, is that there is a risk that the AP might not be willing to take on assets that are very hard to sell quickly, throwing a wrench into the whole process of keeping the fund’s net asset value in line with its share price. That would be reflected in a widening of the bid-ask spread for the ETF—the difference between the price investors can get for selling shares and the higher price they would have to pay to buy the shares.

The concern that this could happen to a fixed-income ETF is based in part on changes in recent years in the fixed-income markets. Financial institutions in general are more averse to the liquidity risk that some debt securities pose, in part because of increased regulation governing the institutions’ risk exposure. Investment banks, for instance, hold 80% less corporate bond inventory than a decade ago.

Ultimately, according to many traders and market participants, concerns around ETFs and fixed-income holdings will only be mitigated when there is more transparency in the market, as more securities are quoted and traded electronically. Currently, only about 10% to 25% of the secondary trading in corporate bonds—depending on the amount of each bond in the market and the issuer’s credit quality—is electronic. The rest is done via online messaging and phone calls.

Continue reading Ari Weinberg’s dissertation directly via the WSJ


Attn: Pension Fund Mgrs: ETF Trading Choices Can Affect Costs and Execution

  By Ari Weinberg | November 26, 2012    

Pension fund managers considering expanding their use of exchange-traded funds must always bear in mind that trading ETFs is entirely different from trading stocks.

Entering a transaction without a clear understanding of the market dynamics for the ETF and the underlying stocks can be costly without the right precautions. The market impact can be more than the fee in basis points cited in the funds’ materials.

“The implementation of a trade is very important and, in some cases overlooked,” said Tim Coyne, head of ETF capital markets for State Street Global Advisors in New York. SSgA sponsors nearly $300 billion in U.S. exchange-traded products. Only in the past few years, with the surge in ETF issuance and trading, have market makers and institutional agency brokers begun to offer ETF-specific implementation shortfall models.

One of the selling points for ETFs is that they can be more liquid to trade than their underlying constituents, but this is only the case in a handful of funds, said Alex Hagmeyer, vice president for data analytics at Markit in Naperville, Ill.

Estimating market impact — the spread from arrival price to final price — to include the notion of ETF creations and redemptions can be complicated by market conditions. And the dynamics of ETF trading have several brokers and data analysts refiguring their implementation shortfall estimates, taking into account that liquidity in the ETF is not the same as the total liquidity available to the investor.

For pension fund managers passing through ETFs in a manager transition or when adding a liquidity layer in broad-market ETFs, market impact models may seem a distant concern but basis points on large transactions can add up.

“A lot of ETFs are quoted by market-making algorithms,” said Chris Hempstead, director of ETF Execution at WallachBeth Capital in New York. For this reason, the impulse to get filled instantaneously by sweeping the limit order book can have a negative impact on an ETF trade.

Mr. Hempstead paints a scenario of an ETF order for 10,000 shares — 1,000 shares filled at the displayed price and 9,000 a nickel away. “If the quotes fill in around your trade (back to the original price), you probably paid too much,” said Mr. Hempstead.

For the entire P&I article by Ari Weinberg, please visit Pensions&Investments online

Buying an ETF for More Than The Ticker

Courtesy of Forbes Contributor Ari Weinberg

July 30

If you invest in exchange-traded funds, you’ve probably heard about the forthcoming service from IndexUniverse.

If you really follow ETFs, you’ve probably wondered what took them so long.

Years in the making, publisher IndexUniverse is finally rolling out its own ratings and analysis service for ETFs. Currently in commercial beta for financial advisers, institutions and other professionals, ETF Analytics takes a different tack than uber, fund-rating firm Morningstar (MORN).

IndexUniverse rolls up its individual ETF analysis into both letter and number grades, while leaning on its current ETF classification system for sectors, themes, styles and more. The service is launching with evaluations on all equity-based ETFs and will eventually cover fixed income, currencies and alternatives.

But Zagat of ETFs it’s not. And, at an initial price of $3000, the service is not for the faint of heart or light of wallet.

For top-level insight on what an individual investor can glean from the new product, I sent over a few questions to Matt Hougan, President of ETF Analytics for IndexUniverse.

AW: What is the biggest or most common mistake investors make when evaluating an ETF?

MH: Just buying tickers.

We see far too many investors just buying the ETFs they are familiar with, or trusting how ETFs are marketed, without looking under the hood.

Take the iShares FTSE China 25 Index Fund (FXI). It has the bulk of the assets for ETF investing in China. But the truth is: It does a terrible job capturing China. FXI has no exposure to technology and very little exposure to consumers.  Eighty percent of the portfolio is invested in old-school, ex-government firms, with none of the entrepreneurial, middle-class-driven growth that most investors want from China.

A fund like SPDR S&P China (GXC) gives you much better exposure, but investors don’t bother to look.

AW: Should buyers differentiate between products for “traders” and “investors?” Continue reading

Cash Management ETFs Will Boom..

Commentary below courtesy of Paul Amery, IndexUniverse.eu

Forbes columnist Ari Weinberg points out that bond ETFs should be seen as the “money market fund of tomorrow”, and he’s right.

Exchange-traded funds (ETFs) are well-positioned to make significant inroads into the US$2.7 trillion money market fund (MMF) sector, which is fighting a fierce rearguard action to maintain the fiction that fund net asset values can be kept stable.

In a vociferous lobbying campaign targeted at the US securities regulator, the Securities and Exchange Commission, a long list of US corporate and state treasurers say they can’t imagine a world in which MMFs might be allowed to “break the buck”—ie, have values that could fall below a dollar a share.

The chairman and namesake of the Charles Schwab Corporation, which manages US$160 billion in money market funds, told the SEC last month that MMFs are low-risk. “In 2008, at the depth of the financial crisis,” said Schwab, “only one money fund lost value for its clients. It lost one percent of its value; that is just one penny of the US$1.00-per-share price.”

But SEC chairman Mary Schapiro offers up a different version of events. She pointed out recently that over 300 money market funds have been bailed out by their sponsors since the 1970s. Just because MMF investors lost out only once or twice because fund sponsors stepped in to hide losses on the other occasions doesn’t mean that there isn’t risk to the whole system, in other words. Continue reading