LIVE ETF Trading Session: How to Achieve Best Execution When Investing in Size in ETFs Matt Hougan Moderator President, ETF Analytics Global Head of Editorial IndexUniverse Dave Nadig Moderator Director of Research IndexUniverse Reginald Browne Panelist Managing Director Global Co-Head of the Listed Derivatives Group Knight Capital Group David LaValle Panelist Vice President, Nasdaq Transaction Services NASDAQ OMX Andrew McOrmond Stan Ueland Panelist Managing Director WallachBeth Capital LLC Panelist Vice President First Trust Bid/Ask Spread Sell at Bid, Buy at Ask Bid/Ask Spread Sell at Bid, Buy at Ask Bid/Ask Spread Impact Bid/Ask Spread Market Order: Buy 1000 shares ABC Market Order: Buy 1000 shares XYZ Solution Limit Orders: Buy SPY Under $100 Sell SPY Over $100 Stop Limit Orders: Buy SPY Under $110, if it’s traded through $100 Sell SPY over $90, if it’s traded through $100 1435 ETFs 77 new in 2012 875 in Registration Spreads: ETFs vs. Underlying SPY IWM ETF Average Spread 0.01% 0.01% Underlying Average Spread 0.03% 0.36% ETFs vs. Consolidated Tape % of Total Market (incl. OTC/BB) ETF Trading Activity % of Cons Tape % of Value Traded 0.3 0.2 0.1 0 14/03/2011 13/03/2012 Elephants & Knotholes Trade Bulls & Chinashops Trade ETF = Platypus Mutual Fund + = Stock How An ETF Works: 100 shares of SPY Please! Broker $9,723 100@ $97.23 How An ETF Works: ETFs, Inc. ? ETF Anatomy: Creation/Redemption: Authorized Participant $2.5 million ETFs,@Inc. 100K $25 MSFT AAPL CSCO CAT IBM ETF Anatomy: Creation/Redemption: Authorized Participant 100K @ $25 IBM MSFT ETFs, Inc. AAPL CAT CSCO ETF Anatomy: Creation/Redemption: Authorized Participant 50K @ $25 ETFs, Inc. CSCO IBM CAT MSFT AAPL Why Be An AP? 100K @ $25 Authorized Participant Why Be An AP? IBM MSFT AAPL CAT CSCO 100K @ $25 Authorized Participant Asset Allocation of an Average1 Public Fund ETF coverage available for every asset and sub-asset class in the portfolio MINT FPX QAI SLVY ICF DBC IGOV Domestic Equity Domestic Fixed Income EUSA International Equity Emerging Markets Equity International Fixed Income Commodities/Real Assets Real Estate VWO Private Equity Hedge Funds Venture Capital CWI 1 Simple BND average of asset allocation percentages of 40 public fund respondents to Council of Institutional Investors’ 2011 Asset Allocation Survey. Cash Equivalents Other Cost-Efficient Transition Vehicle Hypothetical Scenario  $330 million emerging markets equity allocation  Two managers running active strategies; Manager B has a succession problem  Fund wants to maintain exposure to companies focused on consumer goods and services in emerging countries while seeking a replacement for Manager B  Manager B’s allocation is $100 million $10 billion total portfolio 3.3% in Emerging Markets Equity Order Book for ECON Source: Bloomberg, as of 9:48 a.m. on March 9, 2012 The Trade Manager B’s Portfolio • • • • • • • Brasil Foods SA Genting Berhad Tiger Brands Ltd Hyundai Motor Group Samsung Electronics Nan Kang Rubber Tire Titan Industries ECON • • Dow Jones Emerging Markets Consumer Titans Index Limited secondary market liquidity (156k 30-day ADV) Options     Liquidate stock positions and buy $100 million (4.1m shares) of ECON in the secondary market Liquidate stock positions and buy $100 million of ECON on risk using a combination of primary and secondary market access Combine in-kind transition with creation process to buy $100 million of ECON1 Liquidate stock positions and buy $100 million of ECON by creating new shares through the primary market 1 This option is only realistic if: (a) substantial holdings overlap exists between the original portfolio and ETF and (b) the size of the trade is large enough to ensure the relative costs associated with transferring securities is smaller than the costs associated with other trading options. Annualized Total Cost of Ownership - $100m ECON Expenses (in bps) Secondary Market Primary Market Hybrid ETF expense ratio 85 85 85 Brokerage commissions w/in ETF1 8.7 8.7 8.7 Spread on ETF shares2 16 N.A. 16 Brokerage commission on ETF shares traded3 8.2 8.2 8.2 Creation fee (charged by ETF)4 N.A. 0.1 0.1 Up to 100 50 50 218 152 168 Estimated market impact5 Total cost 1 Calculated by taking the dollar value of commissions reported in the fund’s most recent SAI, annualizing this figure, and dividing it by estimated average assets in the fund since inception. 2 Based on Bloomberg data on March 8, 2012. Spread was approximately $0.04. 3 Assumed a commission rate of $0.02 per share and a market price of $24.36 for ECON. 4 Most recent SAI for ECON lists a creation fee of $1,000. 82 creation units would be required to deliver 4.1 million shares (notional value of approximately $100 million) of ECON. 5 Based on Knight’s proprietary statistical trading data, which is a reflection of both real-time circumstances during March 2012 and historical market data. The Beauty of iNAV iNAV = Indicative (or Intraday) Net Asset Value IOPV = Indication of Portfolio Value IV = Indicative Value (especially for ETNs) Yardstick for the current Bid/Ask Estimating Fair Value 50 USD 45 40 35 30 25 Premium Last Price NAV 25% 20% 15% 10% 5% 0% -5% -10% The Crushing Horribleness of iNAV  iNAV’s flaws in:  International Funds  Bond Funds  Commodity Funds  and any other asynchronous things Sometimes international markets over lap: …But not always: Reginald Browne Panelist Managing Director Global Co-Head of the Listed Derivatives Group Knight Capital Group David LaValle Panelist Vice President, Nasdaq Transaction Services NASDAQ OMX Andrew McOrmond Stan Ueland Panelist Managing Director WallachBeth Capital LLC Panelist Vice President First Trust