Thomas Smykowski, Filip Skala, CFA
Q: How has the growth in ETFs made them a more attractive transition management tool?
Thomas Smykowski: ETFs are a scale business, and as they’ve grown their pricing has become more competitive. When an investor is transitioning to a new manager but wants to maintain exposure to the market in the interim, the cost advantage of integrating ETFs into your strategy is difficult to beat. Rather than buying all the components of an index in the cash market or turning to derivatives, institutional investors can buy an ETF. They then receive professional management for a relatively low fee and can invest for the short term or over a longer period.
Q: Hasn’t that been the case for some time now—at least for anyone looking for exposure to a broad index like the S&P 500?
Filip Skala: What’s new is that there are now so many options among ETFs that it’s easy to create the desired exposure given the asset owner’s investment strategy. If they want exposure to a niche market, they can achieve it through individual ETFs, or we can assemble a customized basket of ETFs. This is true not only for equities, but for fixed income, real estate and commodities strategies as well.
Q:What about liquidity, especially for those niche-market ETFs? Can large asset owners move in and out of them without impacting their price?
Skala: It’s a much more liquid market than you might imagine. While some ETFs are not very liquid in the secondary market, many are made up of constituent components which are very liquid. A specialized ETF trading desk like ours will have the capabilities to execute a significant volume of ETF trades on a creation/redemption basis, meaning it will buy the underlying securities of the ETF and deliver them to the ETF provider in exchange for units of the ETF. In our case, even if an ETF is not very liquid in the secondary market, we can seamlessly execute sizable trades in one day—maybe several times the typical daily volume for that ETF.
Q: Beyond low management fees, what other benefits do ETFs offer during manager transitions compared to, say, buying futures contracts on stock or bond indexes?
Skala: We already hinted at the first benefit. You can gain more exposure to a particular sector, or even a factor, through ETFs than you can through broad index futures. In addition, ETFs provide transparency of holdings and offer insight into client exposure within an asset class. Finally, unlike with futures, you don’t have to worry about rolling them forward and incurring costs if you’re trying to maintain exposure over a longer period of time.
Q:As an experienced transition management provider, is there anything you’re offering clients that wasn’t available to them in the past?
Smykowski: We’re proud of the breadth and transparency of our offering, but perhaps its most unique component is the proprietary system we use in rebalancing ETFs to stay aligned with their respective indices. The system monitors transactions and advises clients on which securities are likely to be trading at heightened volumes. As a result, clients may be able to take advantage of these projections when implementing their transition strategy. Let’s say we have a transition client selling a small-cap portfolio. We can identify the names in the portfolio which will be part of an upcoming rebalancing, and gauge whether the names will trade in the same or opposite direction. If it’s in the same direction, we might trade the names before the rebalancing so we don’t expose the client to additional impact. Conversely, for names that will trade in the opposite direction, we might find crossing opportunities between transition clients and our rebalancing order flow. Such crossing opportunities can minimize spread and impact for clients.
