Transparency Or NAV Trading?

Matt, I think improved transparency would be good, but I’m not sure it’s at the top of my wish list of possible enhancements to ETFs.

Just as Morningstar’s Bradley Kay argues, I’ve written in the past that swap-based ETFs could disclose their collateral baskets more frequently than semi-annually. And, judging by Manooj Mistry’s comments in the FT article you refer to, at least one ETF provider, db x-trackers, is considering making that information more readily available to investors.

Having said that, I’m not sure how much use I would be able to make of it – you’d have to be an equity finance specialist to take a view on whether the collateral represented value to the ETF or not – but at least the provision of the information might help to dispel some of the wilder rumours about the riskiness of swap-based products. So all credit to Deutsche Bank if they implement this change, in my opinion.

On the other hand, there appears to be little prospect of those ETFs involved in securities lending disclosing to whom securities have been lent and what’s on loan. Nobody in the securities finance business does this, apparently, and for an obvious reason. Securities are usually lent to be shorted, and short sellers want their activities kept as confidential as possible – regulatory requirements notwithstanding – in case they are targeted for a short squeeze. Indeed, there has historically been very little information made available on activities in the securities lending market, even to the participants: Data Explorers has built a highly successful business around filling the gap.

So if swap-based ETFs improved collateral disclosure but replication-based ETFs didn’t reveal their lending activities, I suppose there wouldn’t be a level playing field – not that it would necessarily harm swap-based providers should they make their underlying portfolio holdings known.

Whether retail investors care about this, or whether they even know that all these activities go on, is questionable, as you say. Institutions, however, may value transparency and give higher scores (and more assets) to those providers who offer it.

To your suggestion that a restructuring of the financial adviser market in Europe is what’s needed to kick start the retail use of ETFs, which I completely agree with (and which we’re hopefully getting), I’d add another.

As Patrick Armstrong argues in an interview we published earlier today, allowing retail investors to trade daily at the funds’ net asset value would also boost demand. It’s difficult for individuals to know whether they are getting a competitive price when trading ETFs and European regulations don’t mandate that brokers seek out the best available price when quoting buying and selling prices. If you trade at NAV, you’ve eliminated half the spread, at least.

While firms like Armstrong’s can shop around amongst market makers to find the best price for a trade, most retail traders are tied to their main broker. In addition, many smaller investors are pure buy-and-holders (I am in my personal pension plan, for example), so having access to intraday liquidity is nice but not such a big deal. Shaving half a percent off the average purchase cost would be a real advantage, however.

Some ETF providers do offer NAV-based trading to retail clients – again, Deutsche Bank has led the way. But very few of the retail-oriented brokers actually make use of this facility. Selftrade (my own broker) doesn’t, and nor did any of the other firms I surveyed for an article last summer.

The facility that most UK brokers offer to buy ETFs on a regular savings plan – something that comes with ultra-low commission rates – is not the same thing. Most brokers who offer this facility reserve the right to trade intraday when they wish to with client funds accumulated in this way. While I’m not suggesting that they do this at a time that is most advantageous for them – and least advantageous for the client – on the monthly trade date, the client clearly gives up control of execution under such an arrangement. If you trade at NAV, however, you are getting some guarantee of a fair price.

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