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ETFs 102 – Trading Strategies FAQ

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Regardless of whether you are a novice investor or an experienced one, it is always useful to refresh and expand your knowledge of ETFs. Our ETFs 102 Webinar – Trading Strategies, touched on interesting insights into the world of trading ETFs, and below are some of the burning questions investors had following it.

  1. Now that ETFs are easily accessible to the investor directly, is there a need for a Financial Advisers anymore considering that eTorro and online trading platforms has pretty much made the stockbroker obsolete?

    Financial advisers provide more than just asset management. They also provide things like income and annuity management, insurance advice and behavioural coaching for savers. We do not believe that ETFs are a threat to financial advisers. On the contrary, a lot of ETFs are built as tools with financial advisers in mind.

  2. How do the market makers cope on a day when the market crashes and everyone is selling, and no one is buying? And in what circumstances would you be unable to trade ETFs?

    During the coronavirus panic sell-off in March-April 2020, the most volatile market in history, our ETFs continued to trade smoothly every day on the ASX. Whereas some actively managed fund providers were forced to increase their entry/exit fees, and many listed investment companies (LICs or LITs) exploded onto wide discounts, ETFs continued to trade normally.

    ETFs are open-ended funds. This means that supply can always be changed to match demand to ensure that prices remain in equilibrium. In a situation where demand for an ETF falls precipitously – for example, if everyone wants to sell and no-one wants to buy – ETFs can always be redeemed, thereby reducing supply. Market makers would be involved in conducting the redemptions.

    For more information on the role a market maker has within the trading of ETFs, check our Partner Series interview with Susquehanna's Robert Risk. Susquehanna is a private-held securities trading firm – often referred to as a “market maker”, in finance jargon. Market makers work with ETF providers – like us at ETF Securities – and with stock exchanges – like Chi-X and the ASX – to ensure that ETFs trade smoothly throughout the trading day. Market makers like Susquehanna are a critical part of the ETF market. But they are often a background presence, known only to industry insiders. In this video interview, Robert lifts the lid on market making. He starts by walking us through the history of Susquehanna, which started out as an options trading company in Philadelphia in 1987.

  3. How can ETFs outperform underlying securities? Don't ETFs experience the same stress as the direct assets they hold?

    ETFs are not designed to outperform the assets they hold. Instead, they are designed to follow an index and follow the performance of the securities that they hold.

  4. Share dividends, franking credits, etc - do ETFs have to pass these on? Or is this optional by the fund?

    ETFs are trusts (they are not investment companies) and therefore pass on distributions in full, net of fees and costs. They also must distribute all tax liabilities – meaning they also pass on all franking credits. How often ETFs pay distributions varies: sometimes its annual, sometimes semi-annual, and other times quarterly. Income and yield-focused ETFs will typically pay more frequent distributions.

  5. What is the approach of ETFs regarding shareholder engagement and voting rights? Do you engage with management of all companies included in the ETF? How do I find out about your position on investor resolutions?

    We have a proxy voting policy on our website. However, as our shareholdings in most companies are small as a percentage of total shares outstanding, we generally don't engage directly with companies. We will start publishing a voting record shortly and are also looking at engaging a third party to vote in accordance with pending ESG policy. We currently vote on all resolutions.

  6. Does the size of the fund indicate that it might be difficult to trade because it is small?

    Being big does not ipso facto make an ETF easy to trade. And being small does not ipso facto make an ETF hard to trade. Size, in and of itself, does not affect trading.

    Most ETF trading on Australian exchanges is controlled by professional trading companies called market makers. Examples of these include Jane Street, Susquehanna, and Flow Traders. Now, how easy it is for these market makers to trade an ETF is primarily determined by three things:

    1. Trading volumes of the ETF

    2. Trading volumes of the shares the ETF holds

    3. Trading volumes of proxies

    In each instance, the higher the trading volumes, the easier it will be for them to enable ETF trading. While our ETFS Semiconductor ETF (ASX Code: SEMI) is relatively small – with roughly $40 million in assets under management as of 6 August 2021 – it is seeing strong trading volumes for an ETF of its size. This makes things easier for market makers. Additionally, SEMI also owns shares that are heavily traded – such as Nvidia, AMD, ASML –which makes things easier still for market makers.

  7. How many market makers do we on average have covering our ETFs?

    The exact number of market makers covering specifically our ETFs (and other companies) are published on the ASX's website: Market Maker Arrangements. The identity of market makers for specific ETFs is transparent. The number of market makers we have differs between products, but on average would be 2 - 3.

  8. Who owns shares in the ETF? Is it ETF Securities?

    The investors in our ETFs are the beneficial owners of the assets held by our ETFs. We at ETF Securities do not own the shares in our ETFs. Rather, the shares in our ETFs are held with an independent custodian bank (such as JP Morgan and HSBC) and ring fenced such that if ETF Securities defaults, our creditors would have no recourse to the assets.

  9. Do market makers determine the liquidity of an ETF?

    Yes and no. Market makers are usually ‘signed on’ when an ETF is new, and they are crucial for determining how easy it is to get in and out of an ETF at the beginning. However, the liquidity of an ETF is a function of much more than market makers. And not all ETF trading is controlled by market makers. Other important factors include:

    1. Trading volumes of the ETF,

    2. Trading volumes of the ETFs underlying assets,

    3. Trading volumes of proxies like futures.

    In each instance, the higher the trading volume, the more liquid the ETF. At its best, you'd want an ETF that trades a lot, holds underlying assets that trade a lot, and has a deep futures market behind them. For these reasons our gold ETF – ETFS Physical Gold (ASX Code: GOLD) – is one of the most liquid on exchange. GOLD has millions of dollars worth of units that change hands most days. The underlying asset – physical gold bullion – is extensively traded. And there are many proxies, such as gold futures.

  10. Is there an easy way to identify a market maker on screen?

    Typically, the best prices that you see on the screen will be from market makers. This is because they have the best trading technology and have the power to change their prices the fastest. As such they tend to be able to provide the tightest bids and offers on most ETFs throughout the trading day. In terms of identifying market makers for specific trades, in Australia, we are different from the US in that trading here is not fully anonymous. So, if you have a sophisticated brokerage platform like a Bloomberg terminal you can see which broker - or market maker - put trades through for an ETF.