An insight into the real business of ETF trading | FT Alphaville

An insight into the real business of ETF trading

We’ve already written about how city veteran Terry Smith of the Fundsmith Equity Fund doesn’t like ETFs and why he’s worried about the extent to which they are shorted.

But what’s really interesting about his Tuesday blog post entitled ‘ETFs – worse than I thought’ is this enlightening snippet he’s come across — thanks largely to who he is — about how the funds are really utilised and traded by the ‘smart side’ of the financial industry.

As he notes (our emphasis):

Another example of the issues in this sector which recently crossed my desk was a fund raising proposition for a business which undertakes trading in ETFs. It shall of course remain nameless, but it trades, arbitrages and makes prices in ETFs with a particular focus on the less traded ETFs. This company describes itself as a ‘fairly thinly capitalised entity’. There are echoes of the parallel banking system in the Credit Crisis here. It also describes the pace of development in the ETF area as ‘breakneck’. I just wonder whose neck will eventually get broken.

Which, of course, is really the beauty of ETFs for those trading the arbitrages with algos and high frequency trading techniques. The daily VaRs are low, and there isn’t all that much capital tied up compared to traditional funds, because most positions are reset on a daily basis and flow is netted out.

Though, if you want some more insight into the dynamics of how these operations are really run it’s worth perusing some of the publicly available accounts thanks to some Irish-incorporated divisions of a couple of the big names in the industry, available in the Long Room. These groups do not publicly reveal the financial statements of their US-based parent companies.

Related links:
Terry Smith doesn’t like ETFs –
FT Alphaville
Oh no, my ETF is turning Japanese!
– FT Alphaville
ETF investors mistimed the commodity correction (again)
– FT Alphaville
If we build it, they will come
-FT Alphaville