The ETF Revolution: International and Brazilian Perspectives

Transcription

1 5o Congresso Inernacional de Mercado Financiero e de Capiais, Campos de Jordao, Augus 2011 The ETF Revoluion: Inernaional and Brazilian Perspecives Marco Avellaneda New York Universiy Finance Conceps LLC

2 Exchange-raded funds Similar o muual funds, wih addiional flexibiliy: -- shares rade on exchanges -- rading is similar o socks (bid/ask, shor, margin) -- opions on ETFs available -- began as as index rackers -- acively managed and synheic ETFs since mid 2000 s Arbirage: auhorized paricipans can creae or redeem ETFs in ``creaion unis -- creaion unis: 25K o 100K shares -- APs ofen ac as marke makers, providing liquidiy

3 FUND AUTHORIZED PARTICIPANTS Basic ETF Srucure Primary marke Secondary marke SELLERS Creaion* ETF Cash Redempion** Arbirage, Mk-making EXCHANGE ETF Cash BUYERS * Give baske of shares, receive ETFs ** Receive baske of shares, give ETFs

4 Brief Hisory Milesones: 1993: firs US ETF 1998: firs European ETFs : ETPs, firs acively managed ETFs Hisory: 1989: Index Paricipaion Shares, sopped by Chicago Mercanile Exchange (IP prob.) 1993: SPY Tracking S&P 500 (a.k.a. Spiders or SPDRS, issuer: Sae Sree) 1996: BGI creaes WEBS (World Equiy Benchmark Shares), laer called ishares (e.g.: EWZ: MSCI Brazil Index Fund) 1998: Secor SPDRS rack 9 secors of he S&P : 680 ETFs in US wih 610B in asses, increase of 125B in 12 monhs January 2010: US ETF marke breaks he 1,000 billion mark in AUM ETPs= ETFs covering, fixed-income, FX, Commodiies, Volailiy

5 ETF AUM Growh in Differen Markes

6 Global ETFs by Exposure Does no include European synheics

7 March 2011, 60 Larges US-based ETFs by AUM (in $BB; highlighed: ishares MSCI Brazil) Rank Ticker Descripion Marke Cap 1 SPY SPDR S&P GLD SPDR Gold Shares VWO Vanguard MSCI Emerging Markes EFA ishares MSCI EAFE Index EEM ishares MSCI Emerging Markes IVV ishares S&P 500 Index QQQQ PowerShares QQQ TIP ishares Barclays TIPS Bond VTI Vanguard Toal Sock Marke IWM ishares Russell 2000 Index IWF ishares Russell 1000 Growh LQD ishares iboxx Invesmen Grade EWZ ishares MSCI Brazil Index SLV ishares Silver Trus IWD ishares Russell 1000 Value VEA Vanguard MSCI EAFE ETF MDY SPDR S&P MidCap AGG ishares Barclays Aggregae Bond BSV Vanguard Shor-Term Bond ETF IJH ishares S&P MidCap XLE Energy Selec Secor SPDR BND Vanguard Toal Bond Marke DIA SPDR Dow Jones Indusrial VNQ Vanguard REIT ETF HYG ishares iboxx High Yield XLF Financial Selec Secor SPDR SHY ishares Barclays CSJ ishares Barclays Year IJR ishares S&P SmallCap FXI ishares FTSE China Rank Ticker Descripion Marke Cap 31 VEU Vanguard FTSE All-World ex-us JNK SPDR Barclays Capial High IWB ishares Russell 1000 Index PFF ishares S P U XLK Technology Selec Secor SPDR EWJ ishares MSCI Japan Index IWR ishares Russell Midcap Index VIG Vanguard Dividend Appreciaion ETF IVW ishares S&P 500 Growh DVY ishares Dow Jones Selec EWC ishares MSCI Canada TBT Proshares UlraShor 20+sy IAU ishares Gold Trus VUG Vanguard Growh ETF SDY SPDR S&P Dividend VTV Vanguard Value ETF VB Vanguard Small-Cap ETF VV Vanguard Large-Cap ETF IWN ishares Russell IVE ishares S&P EWY ishares MSCI Souh Korea SHV ishares Barclays Shor TSY IWO ishares Russell XLU Uiliies Selec Secor EPP ishares MSCI Pacific ex-jp XLI Indusrial Selec Secor VO Vanguard Mid-Cap ETF DBA DB Agriculure Fund IWS ishares Russell Midcap IWV ishares Russell

8 60 Larges US ETFs by AUM (in $BB; highlighed: commodiies) Rank Ticker Descripion Marke Cap 1 SPY SPDR S&P GLD SPDR Gold Shares VWO Vanguard MSCI Emerging Markes EFA ishares MSCI EAFE Index EEM ishares MSCI Emerging Markes IVV ishares S&P 500 Index QQQQ PowerShares QQQ TIP ishares Barclays TIPS Bond VTI Vanguard Toal Sock Marke IWM ishares Russell 2000 Index IWF ishares Russell 1000 Growh LQD ishares iboxx Invesmen Grade EWZ ishares MSCI Brazil Index SLV ishares Silver Trus IWD ishares Russell 1000 Value VEA Vanguard MSCI EAFE ETF MDY SPDR S&P MidCap AGG ishares Barclays Aggregae Bond BSV Vanguard Shor-Term Bond ETF IJH ishares S&P MidCap XLE Energy Selec Secor SPDR BND Vanguard Toal Bond Marke DIA SPDR Dow Jones Indusrial VNQ Vanguard REIT ETF HYG ishares iboxx High Yield XLF Financial Selec Secor SPDR SHY ishares Barclays CSJ ishares Barclays Year IJR ishares S&P SmallCap FXI ishares FTSE China Rank Ticker Descripion Marke Cap 31 VEU Vanguard FTSE All-World ex-us JNK SPDR Barclays Capial High IWB ishares Russell 1000 Index PFF ishares S P U XLK Technology Selec Secor SPDR EWJ ishares MSCI Japan Index IWR ishares Russell Midcap Index VIG Vanguard Dividend Appreciaion ETF IVW ishares S&P 500 Growh DVY ishares Dow Jones Selec EWC ishares MSCI Canada TBT Proshares UlraShor 20+sy IAU ishares Gold Trus VUG Vanguard Growh ETF SDY SPDR S&P Dividend VTV Vanguard Value ETF VB Vanguard Small-Cap ETF VV Vanguard Large-Cap ETF IWN ishares Russell IVE ishares S&P EWY ishares MSCI Souh Korea SHV ishares Barclays Shor TSY IWO ishares Russell XLU Uiliies Selec Secor EPP ishares MSCI Pacific ex-jp XLI Indusrial Selec Secor VO Vanguard Mid-Cap ETF DBA DB Agriculure Fund IWS ishares Russell Midcap IWV ishares Russell

9 The invesor perspecive: Main advanages of ETFs Reail Invesors -- Diversificaion a an affordable price -- Behave like index muual funds bu are more flexible -- Limi orders, shor-selling, opions -- Lower fees (?) -- Tax efficiency: lower urnover han MFs (no need o sell asses each ime someone sells, less capial gains ax impac) Professionals & Pension Funds -- Used for rading & hedging by pros (HF managers, raders) -- Proxies for marke facors for explaining sock reurns -- Tacical allocaion (core/saellie,..) -- ``Equiificaion of commodiies, currencies and fixed-income Large insiuional growh is expeced going forward wih ETFs replacing radiional MFs

10 Main caegories of ETFs Trackers: indusry secors Trackers: counry Currency: based on non-deliverable forwards (NDFs) Commodiy: based on physical Commodiy: based on rolling fuures Acively managed Leveraged & inverse

11 Examples of Counry ETFs issued in he US TICKER DESCRIPTION AUM ($B) ADV ($M) EWZ MSCI Brazil EWJ MSCI Japan FXI Xinghua EWT Taiwan EWY Korea EWC Canada EWH Hong Kong EWS Singapore RSX Russia EWA Ausralia EWW Mexico ADV=Average daily volume

12 US ETFs providing Brazilian exposure Index Trackers AUM ($ million) EWZ - ishares MSCI Brazil Index Fund 1250 BRF - Small Cap 900 BRXX - Infrasrucure 900 EWZS - Small Cap 60 BRAQ - Consumer 30 BRAZ - Mid Cap 30 BRAF - Financials 8 Leveraged UBR - (2X) MSCI Ulra-long 20 BZQ - (-2X) MSCI Ulra-shor 10 Currency BZF - Real Money Marke Fund 500

13 Srucuring: ETF Zoology 101 All ETFs Synheic (swaps, fuures) Physical Index Commodiy FX, Fixed Income Index Commodiy Leveraged Inverse Acive, exoic Benchmark Tracking `Sampling Acive, long/shor

14 Synheic srucure (``unfunded ) Secondary marke Asses reurn Asses sold Collaeral asses may or may no be relaed o he underlying index

15 Synheic srucure (``funded ) Secondary marke (source: BIS)

16 How does a ypical Index ETF work? (A.: a mix of asses and swaps) Asses Cash

17 Profiabiliy of he ETF indusry in Europe Europe ETF In EUR million EUR million Profi is esimaed a EUR 1.2 B in Europe, EUR 5B globally (including US) Securiies lending revenue is esimaed a 498 mm EUR (2500 MM globally) Indirec revenues are imporan!

18 Physical vs. Synheic? Physical replicaion is preferred by Asse Managers (e.g. Black Rock, Vanguard) wih experise in porfolio managemen and index racking Synheic replicaion is preferred by Banks which have large swaps and srucured noes business (DB, Soc Gen, Surge) and less capabiliy in equiy porfolio managemen This explains he recen surge of synheics in Europe where banks have naural disribuion channels and OTC businesses Energy fuures-based ETFs are he province of banks, in general (e.g. DB), and some specialized commodiy raders

19 Main issue for regulaors: ransparency Need beer disclosure on: Physical Replicaion Securiies lending -- Percenage of NAV len ou -- Collaeral Agreemens -- Who receives he profis from securiies lending? Benchmark index composiion: wha are we really invesin g in? Tracking mehods -- Full replicaion or sampling? -- Repors on sampling effeciveness.

20 Main issue for regulaors: ransparency Synheic Replicaion Need beer disclosure on: Mehod of synheic replicaion (funded, unfunded) Who are he swap counerparies? Wha collaeral aken on he swap? Collaeral ownership agreemens Legal opinion on recourse for invesors in case of defaul

21 ETFs in Lain America Regisraions Primary Lisings Toal Lisings Providers AUM (USD B) Brazil Chile * Mexico Peru * (*) Chile and Peru only allow ETF invesmen by pension funds Mos of Mexico s AUM are in US Index ETFs (Nasdaq, S&P, Dow Jones, Canada, Japan) Larges issuer: Black Rock Significan expansion underway in erms of regisraions ( Source: Black Rock, BM&F Bovespa)

22 ETFs Made in Brazil Curren legislaion, Insrucao CVM 359, allows only for ETFs on Brazilian equiy shares, wih physical replicaion (a leas 95% physical replicaion) According o informed sources, a new Insrucion is under review by CVM, which will allow for ETFs on commodiies, foreign shares and fixed-income Major Fund Symbol AUM ($B BRL) ADV(`000) ADV($m) PIBB Fundo Indice Brasil 50 PIBB ishares Brasil Fundo de Indice BOVA PIBB issued by Banco Iau was firs mover BOVA issued by BlackRock is capuring marke share rapidly

23 Some ideas for ETFs issues in Brazil Commodiy ETFs, especially Agriculural and Mining BDRs no on single socks, bu on major marke indexes! (QQQ, SPY, Eurosoxx, Nikkei, Russell 2K) Cross border ETFs based on regional socks (including Argenina, Chile & Brazil) Very ineresing opporuniy o inroduce new asses o he Brazilian invesor communiy bu The appropriae design of hese new producs is imporan in order o avoid well-known pifalls. Opporuniy o shine

24 Brazilian peroleum or mineral commodiy synheic srucure ETF Collaeralized swap or srucured noe Perobras/EBX Financial Producs Auhorized Paricipans Creaion, redempion Hedge wih physical commodiy Cash vs. ETFs Perobras/EBX BM&F Bovespa

25 Known pifalls in commodiy ETFs: Physical vs. Fuures Physical commodiy: GLD (SreeTracks Gold Shares) IAU (ishares Comex Gold Trus) Fuures-based: DGL (Powershares DB Gold Fund) Fuures-based ETFs are based on mainaining a posiion in a consan-mauriy fuures by rolling from one conrac o he nex as hey reach mauriy This may resul in underperformance wih respec o he spo commodiy for a leas 3 reasons -- rolling coss (including fron-running) -- posiion limis in fuures exchanges limis AUM growh and produce disorions -- conango /backwardaion

26 Growh of Gold Bullion ETFs over he las 6 years GLD s AUM = USD 67 Billion

27 Difference Beween Spo Gold and Fuures-based Gold ETFs

28 Commodiy Fuures: Conango T1 T2 T3 Fuures are said o be in conango if he fuures price increases wih he ime-o-delivery (fuures is higher han spo) If he fuures are in conango, his means ha he ``convenience yield is low and he cos of soring and financing make he forward delivery more expensive as ime goes by

29 Commodiy Fuures: Backwardaion T1 T2 T3 Fuures are said o be in backwardaion if he fuures price decreases wih he ime-o-delivery (fuures is lower han spo) Associaed wih a high convenience yield. For example, renal for gold could be expensive, ec.

30 Fuures-based ETFs: he rolling conundrum Mandae: -- posiion in one or more conracs, aiming o carry a fixed-mauriy -- change (roll) conracs as expiraion arrives di I a df F 1 1 df 1 a 2 F 2 rd I F i value of he index a dae fuures wih selemen dae T i

31 Rolling wih consan mauriy Discree rolling (USO, UNG) a( ) 1, 0, if if T T 1 1 T T 2 2 Presen ime Consan arge mauriy T T1 2 Coninuous rolling (VXX, VXZ) a T2 T 2 T 1 Typically, au > T2-T1

32 Conango implies fuures drop owards spo Simple model for F F ( i) S e ( r d i i )( T ) i conango r i d i 0 S spo price r rae for expiraion T i d i i convenience yield - sorage cos for ma. T i df F ( i) ( i) ds S r d i i d, In a low ineres rae environmen, conango means ha convenience yields are negaive. ( 0 ) d i

33 Consequence for fuures-based ETFs di I a ds S ds S df F (1) (1) [ a [ a r d 1 a r d d a 1 df F (2) (2) 1 a d ] d 2 rd 2 2 ] d rd Negaive drif relaive o spo px if convenience yield is negaive

34 Theory mees pracice: he USO oil ETF

35 UNG: Naural Gas ETF

36 Long-Shor Physical vs. Fuures ETF Since fuures-based ETFs underperform spo, we should be able o profi (heoreically, a leas) from going long physical ETF and shoring he fuures-based ef on he same commodiy. Case sudy: Physical ETF: GLD Fuures-based: DGL X Y reurn of reurn of GLD DGL P P X Y r s P T P T X Y rs 0 1 1

37 A firs back-es (no borrow raes) Theoreical performance: 1.8% per year (daily compounding) 3.3% volailiy per year Sraigh line suggess ha he difference should correspond o funding coss

38 bu borrow raes ``kill his arbirage Assume ha GLD can be financed a general collaeral (e.g. 0.25%), so he Issue is how much does is cos o shor DGL. DGL shor rae= % (from large broker, March 23, 2011). This is a negaive rae: you pay on cash balances.

39 Leveraged ETFs Producs offer a muliple of he daily reurn of a reference index Examples: Proshares Ulra Financials ETF (UYG) Offers a daily exposure o 2 imes he Dow Jones Financial Index (long 200% of underlying index, via TRS) Proshares UlraShor Financials ETF (SKF) Offers a daily exposure o -2 imes he Dow Jones Financial Index (shor 200% of underlying index, via TRS)

40 Pifalls of leveraged ETFs for buy-and hold invesors Issues have been raised in he markeplace peraining o he suiabiliy of leveraged ETFs for long-erm invesors seeking o replicae a muliple of an index performance ``UBS AG U.S. brokerage business sopped selling ETFs ha use leverage because such producs do no conform o is emphasis on long-erm invesing Bloomberg News, July 27, 2009 `` Due o he effecs of compounding, heir performance over longer periods of ime can differ significanly from heir saed daily objecive. Therefore, inverse and leveraged ETFs ha are rese daily ypically are unsuiable for reail invesors who plan o hold hem longer han one rading session, paricularly in volaile markes FINRA Regulaory Noice, June 31, 2009 SEC issued a similar warning noice in 2009

41 8/4/2008 9/4/ /4/ /4/ /4/2008 1/4/2009 2/4/2009 3/4/2009 4/4/2009 5/4/2009 6/4/2009 7/4/2009 Tracking error: UYG vs. 2X IYF, 1 year UYG 2X IYF Lack of recovery in he bull mk of Q1 09

42 8/4/2008 9/4/ /4/ /4/ /4/2008 1/4/2009 2/4/2009 3/4/2009 4/4/2009 5/4/2009 6/4/2009 7/4/2009 Tracking error: SKF vs. -2X IYF SKF (-2)XIYF 50 0

43 Char Seings Scale Char Cursor OHLC Values Rese Ener skf nam SKF/UYG Pas 3 monhs

44 Pas year Noice ha boh reurns are negaive (big) over 1 year

45 Since incepion

46 Anoher example: FAS/FAZ Direxion 3X and -3X Financial ETF

47 Oil & Gas Proshares DIG (long) DUG (shor)

48 LETFs: The discree model f r R R L f r R R f L S R R n S N n n L N n n S n L n L n S ETF expense raio for leveraged ETF he leveraged price of he underlying index or ETF price of ETF over he nh period he leveraged reurn of he underlying index over he nh period reurn of, 1, 1,,,,

49 Relaion beween LETF and underlying index L L S S exp r f s ds convexiy due o daily compounding financing & fees volailiy Avellaneda & Zhang (2009), Cheng and Madhavan (2009)

50 Pah-dependence of LETFs is caused by exposure o volailiy Tracking error: S exp (1 ) ( ) s 0 S0 2 0 L r f ds L Avellaneda and Zhang (2009) examined 56 LETFs since heir incepion and showed ha he formula provides reasonable explanaion for he variaions of LETF prices, i.e. ha he racking error is small

51 Double leveraged bullish ETFs, 2/2008 o 3/2009

52 Double leveraged bearish ETFs, 2/2008 o 3/2009

53 Triple leveraged ETFs, since incepion (Nov 2008 Mar 2009)

54 Tracking SSO (2X SPY) Tracking SKF since December 2007 using he acual prices and he formula

55 Conclusions ETFs provide naural advanages o reail invesors (access), professional invesors and hedge funds (hedging, acical allocaion) and issuers (high-margin business) BM&F Bovespa, as a leader in regional and BRIC capial markes, is a naural habia for expanding local & regional exchange-raded producs Commodiies: his is an area where Brazil can shine, especially in srucuring physical or swap-based producs on gold, agriculure and minerals Poenial new businesses can arise as a consequence of his which are beneficial o he counry s economy

56 References Consaninides and Arnold, In he ETF Labyrinh, where does he hread begin? (July 2011), Deusche Bank, Global Markes Research Ramaswamy, S., Marke Srucures and Sysemic Risks of Exchange-Traded Funds, BIS Working Papers, April 2011 BlackRock, ETF Landscape, Indusry Review, end of Q Os Fundos de Indice (ETFs) no Brasil, Revisa Bovespa. hp:// Cheng, Minder and Madhavan, Ananh, The Dynamics of Leveraged and Inverse-Exchange Traded Funds (April 23, 2009). hp://ssrn.com/absrac= Avellaneda, Marco and Zhang, Sanley Jian, Pah-Dependence of Leveraged ETF Reurns (May 14, 2009). hp://ssrn.com/absrac= Non-Tradiional ETFs, FINRA Regulaory Noice (June 2009). Leveraged and Inverse ETFs: Specialized Producs wih Exra Risks for Buy-and-Hold Invesors, SEC Aler (Augus 18, 2009). hp://