[ I N D E P T H | E T F s ]
one , there is the additional risk in the judgement of a fund manager to pick and choose when to buy and sell .
“ If you go for discretionary management , you are trusting the skill and judgement of that portfolio manager or investment team . If you look back at history , some managers can get it right and some don ’ t - being consistent through all market cycles has been a challenge ,” says Li .
It could also prove difficult to convince market makers of the merits of active ETFs taking centre stage in Europe . Market makers create individual buying and selling markets between issuers and investors , operating on small margins made from each transaction .
It is because of these small margins that they prefer as much transparency as possible . If they know the exact value of an ETF it allows them to trade it more easily .
“ Market makers , such as ourselves , need to fully understand the constituents of the basket they are pricing . While this is straightforward in passive ETFs , the constituents of an actively managed ETF are variable , which adds complexity and sometimes lower transparency . As a market marker , our trading desk can only price such instrument when its fully up to speed with what is in it ,” says Ron Heydenrijk , European head of sales and external relations at Flow Traders .
“ Actively managed ETFs are typically more difficult to hedge , because the further you go away from the general benchmarks the less derivative products you can use to hedge .”
Elsewhere , the fragmented nature of the European market could be slowing the progress of active ETFs , as its various currencies , geographies , settlement depositories and exchanges mean that a significant portion of ETF trades are not conducted on exchange .
“ We see a good percentage of [ ETF ] trades done via multi-lateral trading facilities ( MTF ) as well as onexchange , with approximately a 70 / 30 split between MTFs versus on-exchange activity in Europe ,” says Franklin Templeton ’ s Xavier .
The natural fragmentation of the European market has diluted the liquidity available on exchange and subsequently forced ETF traders to find liquidity off-exchange in the form of request for quote ( RFQ ) platforms .
“ Relative to the US , there is lower on-screen liquidity in Europe . There is , however , significant off-screen liquidity through RFQ platforms , which put market makers in competition with each other , offering institutional investors an efficient way to trade large blocks at attractive spreads ,” adds Heydenrijk .
68 // TheTRADE // Spring 2021