Last Updated: 4 December 2023
I noticed one topic cropping up more and more in conversations and questions at this year’s Inside ETFs conference.
The product-related queries that seemed to dominate last year’s event were still there – although last year the focus was on leveraged and inverse ETFs while this year investors seemed more concerned about the performance of commodity funds and the thorny issue of contango.
But the real focal point of investor discussions increasingly seemed to be on how to use ETFs and, in particular, how to trade them. Andrew McOrmond of WallachBeth Capital, Reginald Brown of Knight Capital and Stan Ueland of First Trust Advisors all gave stimulating talks on how best to execute ETF trades. Specifically, they focused on the use of limit and stop orders, the possibility of achieving better execution than at quoted screen prices, trading at the closing NAV, and the best time of day to achieve tight bid-offer spreads in particular funds.
Seeing it from the trading firms’ perspective, an ETF focus is essential. Not only do exchange-traded funds represent a major component of overall share trading volumes, but concentrating on semi-retail or retail investor business makes sense at a time when institutional trading volumes are still subdued and margins for larger investors’ trades are wafer-thin.
It’s worth reiterating how the world of trading has been turned upside down over the last decade. In the US, the introduction of decimalisation for share price quotes in 2001 and the SEC’s regulation NMS of 2005 (which linked all exchanges and market makers and flattened out many price inefficiencies in the US market) have led to an explosion of algorithmic, high-frequency trading.
There do remain some inefficiencies in the structure of the securities markets; in particular, complaints have arisen that certain traders have unfair, preferential access to pre- and post-trade price data without being subject to the capital and reporting requirements typically associated with the dealing firms who have exchange membership. (See, for example, this report from yesterday’s FT, and this excellent summary of the issues from Jacqueline Doherty of Barron’s).
At the same time, it’s hard to agree with the alarmist comments from those who argue that high-frequency trading is a bad thing. After all, as one blogger has commented, “Telegraphs and telephones also brought their own, earlier versions of high-frequency trading. As did stock index futures.”
Technological change and greatly increased competition has benefited all investors, in other words, as costs and dealing spreads have been driven down.
In Europe, ETF trading does not (as yet) constitute such a large proportion of overall stock market volumes, though ETFs are steadily growing in importance. Add in the proliferation of exchanges and other trading facilities and the impression of chaos is reinforced. Margins for ETF traders in Europe are still considerably higher than in the US, as well.
But while a European ETF investor still faces the complexities of multiple listings and “hidden” off-exchange trading volumes, it seems a good bet that competition will drive trading costs down much further. And market participants eagerly await the next version of the MiFID directive to see if there will be compulsory post-trade reporting in ETFs, enhancing market transparency.
2010 could therefore be the year of the traders. Opportunities abound for those market making firms who can deliver efficiencies to their clients, as they do for advisory firms who can show that they are accessing market liquidity in the best manner.