Andre Horovitz view on ETFs in modern Corporate Treasuries


Q: What factors are currently affecting the ETF market?

For the market as a whole, the ETF segment seems to be blooming as investors tend to be increasingly concerned about the high cost of traditional investment vehicles with the historically proven suboptimal delivery of expected returns – especially after costs, commissions, etc. As such, many investors (individual and institutional alike) have pursued a change of heart strategy as they migrate towards passive investment vehicles. The current growth in AuM of the premiere investment funds companies covering such strategies stands as a testament to the validity of the bespoke trend. Indeed, Vanguard, Dimensional and iShares have recently gained a higher than expected share of the overall investment pie and this trend seems to continue. Beyond cost, the ability to match indexes (the case of iShares and other ETF companies) with low TEV (“tracking error volatility”) seems to be the criterion that most investors consider in their choice of providers. But, as well evidenced by the success of Vanguard and Dimensional, passively managed accounts geared to perform better than wide market indexes over a long investment period seem to complement ETFs in the current environment. It appears that the more uncertainty the traditional capital markets are throwing in the game (higher interest rates, political instability, environmental concerns, Brexit, € break-up, the “Trump Factor”, etc.), the more investors flock to index tracking vehicles or passive investment alternatives. Another criterion, which will be addressed in more details under point 3 is market liquidity. This has been a key differentiator among market makers for ETFs in the past and looks to continue to being a major KSF for market participants.

Q: What are the benefits of institutional investors of using ETFs in the current climate?

Much of the question has been addressed above, but I would like to add that  ETFs take away the uncertainty of underperforming due to specific (idiosyncratic) risk taking and as such the main focus rests in choosing the appropriate index (or the combination of indexes) congruent with the investor´s risk profile. As such, the ETF market has added an important pillar of institutional portfolio management, as it focuses more on the issue of strategic asset allocation leaving tactical asset allocation to be effected in an efficient and low-cost manner.

Q: To what extent are corporate treasurers currently using ETFs? Has this changed in recent years?

Corporate treasurers are mandated to immunise their institutions from market risks (in the case of commercial banks, predominantly interest rate re-pricing risks and cross currency exchange rate risks – but recently also credit migration and default risks – under the so-called “credit treasuries”). Equity and commodity markets are less of a concern to corporate treasurers, although recently (also due to the very low yields of fixed income vehicles), treasurers have been increasingly deploying investment funds also into these asset classes. For the latter, ETF markets have become attractive vehicles as they are typically highly liquid (see comment in Point 1) and offer a broad range of attractive opportunities.

Q: What developments are you seeing in terms of the range of products available?

As mentioned in Point 3, bank treasurers traditionally hedge the market risks in banking books via “macro hedges” involving “unfunded derivative transactions” such as interest rate forwards and swaps or rolling portfolios of financial futures. As ETF markets became ripe and liquid, it is quite conceivable to see also the usage of ETFs as vehicles for financial hedges, especially considering the very low costs and high market liquidity. There already are a few examples of “proxy hedges” in credit markets accomplished by usage of ETFs and one should be expecting an enlargement of the pallet of products in this asset class. Given the high volumes and high frequency of trades, this possible trend could blow some significant wind in the sails of the ETF markets going forward.

Q: What should treasurers be aware of when using ETFs?

The key concern is market liquidity, especially under stress scenarios. Here the new BCBS (Basel Committee on Banking Supervision) recommendations on Interest Rate Risk in the Banking Books management (“IRRBB”) are helpful in ascertaining the potential adverse impacts of stress scenarios. Treasurers should also be concerned about residual risks associated with ETF positions since in many cases, ETFs cover indexes that tend to be broader in reach than individual institutions´ required hedges.

Q: What pitfalls should they look out for?

I believe that this question was already addressed under Point 5.

Andre Horovitz view was published in 

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