The ETF Handbook

How to Value and Trade Exchange Traded Funds

David J. Abner

• Verlag: Wiley
• Jahr: 2016
• ISBN:
  9781119193913
• Auflage: 2
• Thema: Business
• Thema: Investimenti e titoli

Professional-level guidance on effectively trading ETFs in markets around the world

The ETF Handbook is a comprehensive handbook for using Exchange Traded Funds, designed specifically for institutional investors and professional advisors seeking to improve ETF profitability. While ETFs trade like stocks, they are not stocks—and the differences impact every aspect of their use. This book provides full guidance toward effectively monitoring, analyzing, and executing ETFs, including the technical details you won't find anywhere else. You'll learn how they work, where they fit, and who is using them, as well as the resources that exist to provide access for investors. This new second edition includes updated coverage on how business has moved from niche to mainstream, ETF performance and issuers around the world, and changes to the users of ETFs in the US. The companion website features instructional video, as well as ready-to-use spreadsheets for calculating NAV and IIV.

Most of the literature surrounding ETFs is geared toward individual investors or traders, but this book is written from the professional perspective—complete with the deeper mechanical information professionals require.

• Learn the analysis and execution methods specific to ETFs
• Discover why ETFs require a sophisticated level of skill
• Consider how ETFs perform in different market environments
• Examine the impact of managed ETF portfolio growth

ETFs are incredibly flexible and valuable tools, but using them effectively demands a more sophisticated skillset, even among professional money managers and traders. Daily volumes and spreads do not tell the full story regarding availability and liquidity, and treating ETFs just like stocks can dramatically impact profits. The ETF Handbook is the professional's guide to the ETF markets worldwide with expert insight on the technical details that matter.

Part One
Introduction to the ETF Market Place

It is hard to believe it all started under a buttonwood tree. The Buttonwood Agreement was signed on May 17, 1792, creating the New York Stock and Exchange Board, now the NYSE. It was a humble beginning for an industry that would guide the evolution of business for many years to come. Two hundred years later the first U.S. ETF was listed on an exchange. Investing was about to change again and become democratized for investors. A wide variety of asset classes and investments from around the globe has become available to any investor. The prices are reasonable and the degree of transparency unprecedented.

This is a book about change. The use of Exchange-Traded Funds is indeed a revolutionary change both for investors and for those in the financial services industry. Never before have investors had the transparency, liquidity, or access now available in the form of ETFs. The products have packaged new and old indices, and all variety of asset classes, neatly into one-trade tools usable by all levels of investors. ETFs are enabling financial advisors to broaden client portfolios, tailor them to better manage risk, and bring down the costs for their investors. And investors are ever more eager to bring ETFs into their portfolios to take advantage of these benefits. This book is written for investors of all sizes. There will be information useful for institutions needing methods of implementing large-size portfolios in the products, and there will be information valuable for the smallest retail investor who needs to understand this revolutionary new product.

This updated edition is split into three parts, which increase in complexity, starting from history proceeding through advanced ETF valuation.

PART ONE

Part One of this book is split into three chapters:

1. Chapter 1 takes a brief stroll through history, highlighting milestones that crafted the modern financial system. The structure and features of mutual funds and closed-end funds are discussed as they are the two other major products in the investment landscape. The chapter then delves into the distinct ETF structure and the purpose of its introduction into the modern-day portfolio. It will be valuable to look at the advantages of ETFs in comparison to other products to determine what fits best in a portfolio. The chapter ends in an examination of the benefits of this growing investment tool.
2. Chapter 2 maps out the process of building an ETF. This includes the development of the underlying basket of assets and the screening of its underlying constituents for proper liquidity. It will help investors understand the why and the how of product development. The chapter also explains the basic nature of the creation and redemption process of ETFs.
3. Chapter 3 discusses the intricacies that come with bringing a product to market. This chapter focuses on how all the moving pieces have to work in unison for optimal success. It includes the importance of the relationship with partners and exchanges to lift an ETF off the ground, ensure proper functionality, and keep it growing and working well for its investors. The chapter ends with reasons why an ETF may close and how that may affect investor portfolios.

Exchange-traded funds have now been available as an investment product for more than 20 years. The low fees are the first feature that comes to mind when ETFs are mentioned by investors. Although this alone can be enough of a reason for investors to enter into the ETF marketplace, it can be subordinate to the other benefits of this product. Part One of The ETF Handbook, Second Edition, shows the evolution of the product structure and the variety of benefits these new tools bring to investors. The evolution of the financial markets through technology has helped to make these products available to investors. They have proven to be exactly right for building portfolios in the modern era!

After explaining the evolution and characteristics of the products in Part One, I dive deeply into the actual trading of the products in Part Two. One of the most important benefits of the products is their exchange listing and the myriad benefits that brings to investors, so it is at the core of this book and should be the core of investor knowledge.

In Part Three we will explore how to value ETFs, and the mechanics of calculating Net Asset Value. This section will get into the inner mechanics of the products, enabling an understanding of what is actually happening within them to provide the exposure and returns desired by investors.

Chapter 1
How Did We End Up Here?

By the end of 2014, U.S.-registered investment companies exceeded $18.22 trillion in managed assets. The three largest categories were mutual funds (MF: $15.85 trillion), exchange-traded funds (including non–1940 Act funds, ETFs: $1.98 trillion), and closed-end funds (CEFs: $289 billion).¹ Every investor—from small households to large institutions—utilizes funds. In the year 2000, mutual funds accounted for more than 95 percent of assets invested in funds, with nearly $7 trillion in assets spread throughout 8,370 investment companies. At that time, ETFs accounted for less than 1 percent of the $7 trillion dollar market, with just 80 ETF investment companies sharing the $66 billion in assets. Fast-forward to the end of 2014 and U.S. ETFs are nearing $2 trillion in assets. This accounts for roughly 11 percent of all fund assets in the United States. Over 1,500 investment strategies are now vying for the ETF investor with a wide array of evolving products. We must ask ourselves important questions: How did we get here? Where are we going?

We live in a generation that demands innovation at rapid speeds. That new flat-screen television purchased yesterday is outdated before being removed from the box. The financial markets are not immune to such revolutionary demands of quick and efficient access to everything. What worked yesterday does not necessarily work today. Smart investors should always be looking for the optimal products and techniques to remain on top. The creation of the ETF is a prime example of successful financial market disruption.

Prior to the establishment of the ETF, investors did not have the exposure and access to the financial instruments, benchmarks, and investment strategies that the ETF now makes possible. Looking at new issuances and assets under management (AUM) among ETFs, CEFs, and mutual funds over the last decade, the numbers indicate that mutual funds may be losing their stranglehold on the industry. Exhibit 1.1 displays the new issuance in asset terms of the two major competing products, mutual funds and ETFs.

Exhibit 1.1 New Issuance of ETFs and New Cash Flow to Mutual Funds, 2003–2014, Billions of Dollars

Source: ICI Factbook 2015

This can be contrasted with the flows into ETFs as compared to the flows out of Mutual Funds presented in Exhibit.1.2.

Exhibit 1.2 Flows into ETFs and out of Mutual Funds, 2007–2015, Billions of Dollars

Source: KCG 2016

This chapter looks at the broad similarities and differences among mutual funds, closed-end funds, and exchange-traded funds. It examines why the different features that ETFs possess have enabled them to experience rapid growth over the last several years. We take a brief look at the origin of ETFs and their rapid adoption. Finally, we will discuss what the future holds for this young product structure. Understanding the inception and development of these investment products is imperative before delving into the complexities of these new investment vehicles. In the next few chapters I will delineate how ETFs are initially developed and the ways they are brought to market. Part Two presents strategies for how to position them within your portfolio through efficient trading and understanding of the market. Part Three explains the more technical aspects of how to value ETFs.

THE HISTORY OF INVESTMENT PRODUCTS

This is a book about change. The use of exchange-traded funds is a revolutionary change for investors and for those in the investing business. Modern technology continues to shrink our world. The development of financial instruments is occurring at lightning speed. It is a challenging task to keep informed of the latest techniques and tactics. How did we arrive at modern investment products? A brief walk though history will deepen our understanding of available financial products and how they evolved.

The Birth of Money

The concept of securing wealth for the future by means of investment has always been relevant. The Code of Hammurabi, dating back to 1,750 BC, provides a legal framework for investing. This law aimed to classify the rights of debtors and creditors alike. Long before the invention of money, the barter system was in place. Bartering is the oldest method of trading; it is the concept of exchanging goods and services for other goods and services. It is recorded that ancient peoples have been bartering since 6,000 BC. This allowed for a wide array of products to be distributed across the globe without money. The exchange system of barter, however, had many shortcomings. It required two traders to have products or services of equal value who were also willing to trade at a given time. Another complication was establishing trust between traders and the products or services they offered. As society advanced, the limitations of the barter system yielded to the creation of currency and money.

Currency started by using popular commodities that had the ability to be split into portions. This allowed the accrual of currency in the form of livestock, wheat, beads, clay, bits of metals, and so on. Manufacturers and consumers could now hold commodities that...