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December 16, 2011

ETFs Push Traders Toward Multi-Asset World

Top Stories in 2011

By James Armstrong

Traditionally, single-stock traders have rarely gotten involved with exchange-traded funds. But this year, as ETFs began taking their place as a dominant part of the industry, all traders began looking to these instruments as a gateway to the brave new world of multi-asset trading.

Bryan Johanson, managing director for global index and exchange-traded products at NYSE Euronext, said ETFs can blur the lines between equities and other asset classes, since they themselves are equities, but their underlying assets might be fixed-income products, currencies, commodities or something else.

Currently, 39 percent of ETFs on NYSE Arca track domestic equities, while 26 percent of listings track international stocks. Commodities and futures-based funds make up 14 percent of listings, fixed-income funds make up 11 percent, and currencies funds are 3 percent.

To trade ETFs effectively, firms have to look beyond domestic equities, leveraging their resources on trading desks across asset classes. The expertise required to trade ETFs demands a multi-asset approach.

"That expertise, since it requires a broader understanding of portfolio construction, is typically not what you find on a cash equity desk," said Tom Smykowski, who heads ConvergEx's global portfolio and ETF desk. "You're going to have to open your knowledge base to include different asset classes."

Smykowski noted that over the past year, volumes for ETFs have grown significantly compared with the rest of the market. Earlier this year, ETFs made up between 25 and 30 percent of total volume, but this summer they rose to as high as 40 percent of volume for some days. Some believe that ETF trading added fuel to the volatility, though others argue that investors fled to the vehicles in response to volatile markets.

With ETF volumes that high, equity traders can't afford to ignore the shift toward exchange-traded funds, which differ from traditional equities in a number of ways.

For one thing, volume does not always equal liquidity in ETFs. That is because authorized participants can create new ETF shares out of a fund's underlying assets. They can also redeem ETF shares, converting them back into the underlying assets. Because of APs, an ETF can be liquid even when it's only lightly traded.

Matt Tucker, managing director of U.S. fixed-income strategy at ETF giant BlackRock, said APs have helped to promote even further collaboration among desks specializing in different asset classes, as that collaboration is vital to the creation/redemption process.

Since ETFs are a hybrid vehicle, firms can come to a variety of conclusions in terms of who gets to trade them, Tucker said. While equity desks have traditionally had authority over ETFs, the vehicles can also be traded by those with the most knowledge of their underlying assets. Other firms have chosen to use ETF-specific desks.

With this increased competition, traders who formerly just focused on U.S. cash equities have to broaden their horizons-learning more about fixed-income, commodities, international stocks and foreign exchange.

"It has become important to involve traders with expertise in a variety of instruments," said NYSE's Johanson. "We're seeing more and more exotic and different asset classes that are packaged as an ETF."

NYSE Arca has had more that 265 new ETF listings this year, with more anticipated by year's end. Already, 2011 has broken the previous record set in 2007 of 223 new listings.

"Now you have a ton of volume in hundreds of ETFs that are out there," said Paul Weisbruch, vice president of ETF/options sales at Street One Financial. "There's a lot of communication between desks and departments where they can hedge off exposure and probably more seamlessly get big trades done from asset class to asset class."

 

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