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2. Implementing Investment Decisions with Exchange Traded Products Netherlands CFA conference 21 st November 2012

3. For Professional Investors Only, Not For Public Dissemination Page 3  Introduction  Why is exchange traded product implementation important?  Main methods of implementation  Case Studies  Optimisation Techniques Table of Contents

4. Introduction

5. For Professional Investors Only, Not For Public Dissemination Page 5  Kris Walesby, Head of Capital Markets for ETF Securities □Responsible for Sell-Side relationships  Implementation, why it’s important and why it will grow in importance □Why implementation is important □Main methods for implementation □Case Studies □Optimisation Techniques □Questions and Answers Introduction and overview

6. Why is ETP implementation so important?

7. For Professional Investors Only, Not For Public Dissemination Page 7  Grumeti river  Not possible to avoid □To get to the fertile plains □And to get back The Great African Migration  Annual Event – Tanzania to Kenya  1,800 miles  1.5 m Wildebeest, 300k Zebra

8. For Professional Investors Only, Not For Public Dissemination Page 8 Asset allocation decision Investment Decision Lifecycle Product selection Implementation Initial RebalanceExit Total Cost Of Ownership

9. For Professional Investors Only, Not For Public Dissemination Page 9  Investors naturally focus on headline fees - TERs  However there are other considerations, including  Rebalancing costs  Swap fee  Licensing fee  Implementation costs Implementation costs are becoming increasingly recognised by European ETP investors as one of the most important aspects to focus on Don’t Just Look At The Headline Fee

10. For Professional Investors Only, Not For Public Dissemination Page 10  Implementation is always important  However time horizons dictate the relative importance of implementation to the portfolio manager The Importance of Time Horizons Time HorizonStrategyRelative importance of implementation Long TermBuy and HoldLow Medium TermRegular rebalancingMedium Short TermTactical/OpportunisticHigh

11. For Professional Investors Only, Not For Public Dissemination Page 11 Example European ETPs – One Year Time Horizon

12. For Professional Investors Only, Not For Public Dissemination Page 12 Example European ETPs – One Month Time Horizon

13. Main Implementation Methods

14. For Professional Investors Only, Not For Public Dissemination Page 14 Main Methods for Implementation On ExchangeOTC Risk @NAV

15. For Professional Investors Only, Not For Public Dissemination Page 15 ETPs are priced with reference to their underlying However there are other elements to consider too  What does this mean in practice? Four main elements to an ETP price:  Underlying spread  Level of risk  Creation/Redemption costs  Existing Inventory – This acts as a price reducer Mid Price: - $25.00 Bid Price : - $24.50 Offer Price: - $25.50 Underlying spread Risk spread Creation spread Existing inventory

16. For Professional Investors Only, Not For Public Dissemination Page 16 Main Methods for Implementation: On Exchange Advantages  Anonymous  Centrally cleared  Usually cheap  Usually multiple counterparties Disadvantages  Orderbooks can be shallow  No direct recourse to market maker On ExchangeOTC Risk @NAV

17. For Professional Investors Only, Not For Public Dissemination Page 17 Main Methods for Implementation: OTC @ Risk On ExchangeOTC Risk @NAV Advantages  Large blocks at one price  Direct recourse to market maker Disadvantages  Counterparty risk  Credit Lines need to be in place  Not anonymous

18. For Professional Investors Only, Not For Public Dissemination Page 18 Advantages  No market risk  Paid commissions for little work  Achieve NAV  Lower cost than a risk trade (usually) Disadvantages  No opportunity to price at risk  Negative intraday price move  No possibility to “get inside spread of underlying” Market Maker Client On ExchangeOTC Risk @NAV Main Methods for Implementation: OTC @ NAV

19. Optimising Portfolio Implemetation

20. For Professional Investors Only, Not For Public Dissemination Page 20  Use limit orders where possible  Don’t judge the potential liquidity by looking at historical volumes  Check the trading times of the underlying  Don’t compare closing price to NAV  iNAVs are often useful but not always Capital Markets teams:- a critical aid to optimising implementation Suggestions for Optimising Portfolio Implementation

21. Case Studies: Trading On Exchange

22. For Professional Investors Only, Not For Public Dissemination Page 22  Market makers compete with each other to provide the lowest price for an investor to buy at (Ask) and the highest price to sell at (Bid)  Within these prices the market makers have already included:  The spread of the underlying  Risk that they may be wrong  Existing inventory  Implied cost of creating and redeeming  In this case the “top of the order book” is a spread of 15 basis points or 0.15% = (53.67 – 53.59)/53.59 * 10,000 Trading ETPs on Exchange Example: State Street Euro Corporate Bond (SYBC GY Equity)

23. Case Studies: Trading @ NAV

24. For Professional Investors Only, Not For Public Dissemination Page 24 Client Disadvantages – Further explanation Negative intraday price move

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26. Appendix

27. How does one assess the liquidity of an ETP?

28. For Professional Investors Only, Not For Public Dissemination Page 28 ETPs. They trade like stocks.....  On exchange  Europe:- approximately 7:50 am- 4:45 pm (UK Time:- includes auctions)  Intraday pricing via bid and offer prices  Order book size illustrates market makers buy/sell interest  OTC  Market Makers will offer two way prices  Normally (but not necessarily) larger size order  Normally (but not necessarily) higher commissions ETF Securities Physical Gold (PHAU LN) and Barclays (BARC LN) have the same trading mechanics

29. For Professional Investors Only, Not For Public Dissemination Page 29 …but their liquidity has different drivers  Traditional Securities  Have a limited amount of free float shares available  Liquidity is driven by demand/supply  Historical volumes and trading patterns are used to predict future trading patterns  Exchange Traded Products  Price and liquidity are dictated by the underlying securities not the ETP  Extremely limited “supply/demand” effect as the funds are open ended  Historical volume is only useful to show popularity not tradability  Techniques like VWAP are irrelevant

30. For Professional Investors Only, Not For Public Dissemination Page 30 Primary & Secondary Market - Interconnected Investors trade via the exchanges (Secondary) or OTC directly with a market maker. The market maker will execute the order using existing inventory, via the exchanges or by creating/ redeeming units on the primary market. The decision on this will be based on the balance between what is cheapest and what bears least risk for the market maker. Primary MarketSecondary MarketMarket Makers Existing Inventory Investors ETP 1 2 3

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34. Underlying Liquidity

35. For Professional Investors Only, Not For Public Dissemination Page 35 ETP Liquidity Look at the underlying ETFS Wheat Ticker:- WEAT LN Average Daily Volume:- $1.54m CBOT Future Ticker:- W A Comdty Average Daily Volume:- $1,126m Explanation  ETFS Wheat trades $1.54m per day on average  However, the relevant measure of how much trading can be done is the underlying contract  This trades over $2b per day on average - Ratio:- ETC/Future = 0.14%  Many times over $1.7m ADV could be traded through the ETC with minimal impact  Taking a conservative estimate of 10% of the average underlying trading, this means that $113m can be traded on the ETC without any significant price impact  UBS and BAML have committed to $250m each of liquidity per day for the products they back

36. For Professional Investors Only, Not For Public Dissemination Page 36 Arbitrageurs keep the price close to fair value  Trader sees the ETP trading at $25.70 vs the underlying at $25.50. She:  Buys underlying units at $25.50  Sells ETP units at $25.70  Creates ETP units in exchange for the underlyings i.e. at $25.50  Risk free profit $0.20 per unit Fund: ETF Securities Example ETP Mid Price: $25.00Underlying Offer: $25.50ETP Bid: $25.70 Underlying ETP

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