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ETF Traders Are Leaving Money on the Table, Greenwich Says
Traders Magazine Online News, August 20, 2018
Investors and broker-dealers should start treating ETFs as an asset class all their own. Doing so would help improve execution quality and ramp up client commissions and overall profitability.
More than $5 trillion in assets are now managed in ETFs, which were originally created to provide retail investors with easier and cheaper access to broad swaths of the market. The market has dramatically transformed, however, and is now employed by institutional investors to hedge risk, manage cash flows, gain quick exposures to illiquid market segments, and more.
However, trading practices on both the sell side and buy side are leading to suboptimal executions, limiting ETF growth. For example, many equity broker-dealers and market makers treat ETFs as equities, given they trade on equity exchanges. Many investors take the same approach, trading ETFs with algorithms and using transaction cost analysis (TCA) systems designed for single stocks, rather than ETFs. Further, while fixed-income ETFs trade on equity exchanges, they move like the bond market, putting equity traders far out of their comfort zone.
Market leaders are starting to break away from these long-held beliefs. For clients that need credit market exposure, traders and portfolio managers must explore all of the products at their disposal, and not just those with which they are most comfortable. Similarly, broker-dealer sales teams should be willing and able to offer clients access to the right instrument, and not just those that they cover or the one the client requested.
“Today, the same execution algorithm used to trade IBM is often used to then trade high-yield bond ETFs. While these instruments both trade in the U.S. equity market, the reasons they trade and the way their prices are determined are completely different,” says Kevin McPartland, Head of Research for Greenwich Associates Market Structure and Technology and author of the new report, Letting ETFs Stand on Their Own. “For institutional use of ETFs to grow and mature, long-held structures for managing clients and trading products need to change.”
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