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Noel Archard
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Noel Archard, CFA is a Managing Director and Head of Product for North America iShares. He currently heads the iShares product function in the US, which is responsible for product research and development, product management, the management of iShares in capital markets and product services and... More
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  • Cause or Effect: ETF Trading Volume Impact on Volatility (and Vice Versa)
    Taken from iSharesblog.com

    If you read Russ Koesterich’s blog post from Monday, May 12th, you already have an idea of what has been going on with the price of silver. The commodity was up over 150% over the prior 12 months before going through a downward correction and shedding 30% of value. Our iShares Silver Trust (SLV) became a focal point during the course of the week as volatility spiked, and the usual questions popped up about how people use ETFs, and whether or not ETF trading volume is caused by price volatility, or if it’s in fact a contributor to the volatility. One reporter, noting the net redemptions in SLV last week, asked me if we had any plans to put checks into place to slow down the create and redeem process during periods of market volatility. All of these are great questions, but also indicative of how much we as an industry need to educate the market on how ETFs work.

    SLV was trading at roughly $48 per share just over a week ago, and at the time of this writing has moved down to the $33 range. Over the course of the week when spot silver was hitting new highs, there was trading of approximately $7 billion a day in shares of SLV. The trust itself over that time period averaged more than $16 billion in assets. So over that week, more than twice the assets represented by the trust traded hands amongst investors who wanted to express an opinion on the value of silver. The market makers who help facilitate trading in SLV did redeem some shares over that week, but the redeemed shares added up to less than $1 billion.

    Throughout the time period in question, SLV served one of its primary purposes as an ETF, which is to provide access and liquidity to asset classes in a way that helps diffuse impact on the underlying asset class. $35 billion worth of shares traded, but only $1 billion actually left the trust. One reason this works so well is that the firms who bring shares in and out of the market (by delivering silver to or taking delivery of silver from the trust in exchange for shares) know that they have access to this facility every day. That is how they make efficient markets in ETFs – because they know they can make more (if they are short shares) or deliver shares to us (if long shares they don’t want to hold) in exchange for the underlying asset. Because we don’t introduce frictional costs into this in order to slow down volatility (as suggested by the reporter), we end up with a more efficient product – SLV’s spread was $0.01 wide during the volatile period.

    Which brings me to the question of cause or effect: does ETF trading create the price, or does ETF trading reflect the price activity already in the market? This question is not unique to SLV; we’ve heard it about microcaps, emerging markets, gold, municipal bonds and many others. One basic tenet of ETF design is that you can’t create liquidity out of an illiquid asset class. Somebody has to buy the basket and help create the shares for the marketplace to buy and sell. Silver is a great example. Yes, we saw a lot of trading in SLV that week. But this was in the face of a 150% gain in the asset. During the year that silver was in its upward move, we saw SLV’s net new assets grow by $2 billion. While this might sound like a lot, it reflects less than 1% of the silver produced in 2010 alone. It would be difficult to say that the ETFs have a long-term impact on the price of commodities with such depth. Also, there have been days when silver spot was down significantly and we still saw creates in the trust, clearly refuting the idea that creation/redemption activity and price pressure are related.

    Source: Bloomberg

    iShares Silver Trust (the “Silver Trust”) has filed a registration statement (including a prospectus) with the SEC for the offering to which this communication relates. Before you invest, you should read the prospectus and other documents the Silver Trust has filed with the SEC for more complete information about the issuer and this offering. You may get these documents for free by visiting www.iShares.com or EDGAR on the SEC website at sec.gov. Alternatively, the Silver Trust will arrange to send you the prospectus if you request it by calling toll-free 1-800-474-2737.

    Investing involves risk, including possible loss of principal. The iShares Silver Trust is not an investment company registered under the Investment Company Act of 1940 or a commodity pool for purposes of the Commodity Exchange Act. Shares of the Silver Trust are not subject to the same regulatory requirements as mutual funds. Because shares of the iShares Silver Trust are expected to reflect the price of the silver held by the Silver Trust, the market price of the shares will be as unpredictable as the price of silver has historically been.  Additionally, shares of the Silver Trust are bought and sold at market price (not NAV). Brokerage commissions will reduce returns.

    Shares of the Silver Trust are created to reflect, at any given time, the market price of silver owned by the trust at that time less the trust’s expenses and liabilities. The price received upon the sale of shares of the Silver Trust, which trade at market price, may be more or less than the value of the silver represented by them. If an investor sells the shares at a time when no active market for them exists, such lack of an active market will most likely adversely affect the price received for the shares. For a more complete discussion of risk factors relative to the Silver Trust, carefully read the prospectus.

    Shares of the iShares Silver Trust are not deposits or other obligations of or guaranteed by BlackRock, Inc., and its affiliates, and are not insured by the Federal Deposit Insurance Corporation or any other governmental agency.

    BlackRock Asset Management International Inc. (“BAMII”) is the sponsor of the Silver Trust. BlackRock Fund Distribution Company (“BFDC”), a subsidiary of BAMII, assists in the promotion of the Silver Trust. BAMII is an affiliate of BlackRock, Inc.

    Although shares of the iShares Silver Trust may be bought or sold on the exchange through any brokerage account, shares are not redeemable except in large aggregated units called Baskets.

    May 20 5:41 PM | Link | Comment!
  • Using EWJ to Access Japan: A Price Discovery Case Study
    Taken from iSharesblog.com

    Last week, Alphaville blogger Izabella Kaminska warned investors to “beware your Japan exposure”, stating that the iShares MSCI Japan fund (EWJ) is not a proxy for Japan (or at least, “not completely”). Kaminska noted the sizable premium to net asset value (NAV) that EWJ and other U.S.-listed Japan ETFs have experienced at market close the past couple of weeks, shrugging off the explanation provided by Index Universe that due to time differences “these price discrepancies are not premiums in the traditional sense, . . . but gauges by the U.S. market of the expected value of the underlying securities once they open the following day.” Since the concept of premium/discount in international ETFs tends to cause a lot of confusion, I hope I can shed some light on the subject. 
    First, to address the premium issue. EWJ holds a basket of Japanese stocks that trade on the Tokyo Stock Exchange during its market hours of 9am to 3pm (8pm to 2am ET).  When EWJ opens for trading on the U.S. market the next morning, it can serve as a price discovery vehicle, allowing investors to continue to gain access to the closed securities and help determine a current price based on the most recent news and information. EWJ’s end-of-day NAV is then calculated based on the underlying securities’ closing prices from 14 hours earlier. This means that the closing price (based on current investor sentiment) and the NAV (based on local markets long closed) will almost always differ–a discrepancy that can become more pronounced when there are market-disrupting events in play.  
    You can see how NAV and closing market price are rarely, if ever, going to be the same–but there’s no telling if the difference will be a premium or a discount. This is why the assertion that authorized participants used the time difference to their advantage, “buy(ing) Japanese stocks cheaply (while U.S. markets were closed) for the purpose of creating baskets later to sell to U.S. investors at a premium,” is a bogus one. It’s essentially like saying that a market maker in the U.S. on Tuesday has precise knowledge of where Japan will be trading on Wednesday–never mind all the unknowns that exist in that scenario.   
    Check out the graph below, which maps the percent change in price of EWJ, the U.K.-listed iShares Japan ETF (which also tracks the MSCI Japan Index), and the MSCI Japan Index the week following the earthquake and subsequent tsunami in Japan.  After the index traded down in Japan on Monday March 14th, the U.K ETF opened just north of Japanese markets and later traded almost in lockstep with EWJ during U.S. market hours. News of the escalating nuclear crisis caused further decline during Japan’s Tuesday session before investor sentiment again buoyed the ETFs during the U.K and U.S. trading days. Note that 1.5 hours pass between Japan’s close and the U.K.’s open, and 4 hours pass between the U.S.’s close and Japan’s open–and news is being disseminated around the clock.
     Please click here for standardized performance for EWJ.
     
    Source: Bloomberg 3/13/11 – 3/16/11. Past performance does not guarantee future results. 
    We can speculate about what caused investor sentiment to change direction, but what’s more important is that the market price of the U.K. ETF and EWJ reflected the aggregate view of the underlying basket of securities as determined by the supply and demand seen on the exchange. Each of these ETFs provided an actionable price that incorporated all the current information and risk that the market perceived about the underlying equities, given the fact that these securities were currently unavailable to trade. What’s more, EWJ’s volume spiked significantly during this time period, reaching almost $4B on 3/15 (over 12 times its already substantial average daily volume (ADV) in the month of February). And spreads remained at a penny. 
    Is EWJ a perfect proxy for Japan? I’d go out on a limb and say it’s one of the closest proxies available for U.S. investors. It gives U.S. investors the opportunity to invest in a diversified basket of Japanese securities during U.S. market hours, and it gives the investment world a vehicle to price new information into the securities even when they are closed for trading on their local exchange - that’s about as close as you can get. At the end of the day, EWJ worked exactly how we’d expect it to work in a tumultuous market, and that’s what counts in our book. 
    Source: Bloomberg 
    In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Securities focusing on a single country may be subject to higher volatility. 
    Shares of the iShares Funds may be sold throughout the day on the exchange through any brokerage account. However, shares may only be redeemed directly from a Fund by Authorized Participants, in very large creation/redemption units. 
    The iShares Funds are not sponsored, endorsed, issued, sold or promoted by MSCI Inc., nor does this company make any representation regarding the advisability of investing in the Funds. Neither SEI, nor BlackRock Institutional Trust Company, N.A., nor any of their affiliates, are affiliated with the company listed above.

    Carefully consider the iShares Funds’ investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds’ prospectuses, which may be obtained by calling 1-800-iShares (1-800-474-2737), or by clicking the Prospectuses link. Read the prospectus carefully before investing.

    Investing involves risk, including possible loss of principal.

    The iShares Funds (“Funds”) are distributed by SEI Investments Distribution Co. (“SEI”). BlackRock Fund Advisors (“BFA”) serves as the investment advisor to the Funds. The iShares Blog contributors are affiliated with BlackRock Fund Distribution Company (“BFDC”), which assists in the marketing of the Funds. BFA and BFDC are affiliates of BlackRock Institutional Trust Company, N.A. (“BlackRock”), none of which is affiliated with SEI.

    The strategies discussed are strictly for illustrative and educational purposes and should not be construed as a recommendation to purchase or sell, or an offer to sell or a solicitation of an offer to buy any security. There is no guarantee that any strategies discussed will be effective. The information provided is not intended to be a complete analysis of every material fact respecting any strategy. The examples presented do not take into consideration commissions, tax implications or other transactions costs, which may significantly affect the economic consequences of a given strategy.

    The information provided is not intended to be tax advice. Investors should be urged to consult their tax professionals or financial advisors for more information regarding their specific tax situations.

    Neither BlackRock Institutional Trust Company, N.A., and its affiliates nor SEI and its affiliates provide tax advice. Please note that (i) any discussion of U.S. tax matters contained in this communication cannot be used by you for the purpose of avoiding tax penalties; (ii) this communication was written to support the promotion or marketing of the matters addressed herein; and (iii) you should seek advice based on your particular circumstances from an independent tax advisor.

    This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any security in particular.

    Tags: EWJ, Japan, ETFs
    Apr 07 6:58 PM | Link | Comment!
  • Kauffman Strikes Back (and Out) Again
    Taken from iSharesblog.com

    Here we go again.  Remember last November when the Kauffman Foundation released a report that falsely implied, among other things, that exchange traded funds were responsible for the May 6th Flash Crash?  Well, Kauffman is back, and this time with a new report that is basically more of the same – namely, an inaccurate and misguided attempt to create fear about the structure of ETFs.  While their ultimate recommendation for regulators to reduce the number of fails might be well-intentioned, the path they took to get there is crooked and no thought seems to have been given to unintended consequences. But maybe they are saving that for their next report.

    At the highest level, this new study is focused on the large and growing number of failed settlements in ETFs and mortgage-backed securities (MBS), meaning one party in the trade has failed to deliver the security within the standard 3-day timeframe to the other party in the trade. They then refer back to their first report where they implied that ETFs could implode due to phantom ETF trades being redeemed for real securities. This is where things begin to go off the tracks for me.   I can’t speak to the MBS market, but I do have some insight to share on the ETF marketplace relative to this report. Because the “researchers” once again play fast and loose with terminology, we have to begin by untangling what supposed problem we’re trying to solve.

    Let’s start with some ETF 101.  ETFs are created in the primary market.  When an ETF share is “created” or “redeemed” (not “destroyed” as erroneously labeled in Kauffman #1), an Authorized Participant, or AP, delivers shares of the underlying securities for shares of the ETF, or vice versa.  If an AP is unable to deliver the necessary securities by the settlement date (typically trade date plus 3 days or T+3), the settlement is considered “failed.”  However, the whole trade itself has not failed as the name implies – rather the AP has been required to post collateral in order to delay delivery of the securities, which means the investors in the fund are protected until delivery occurs.  In our experience the occurrence of TRUE failed trades in an ETF create or redeem (meaning the AP’s collateral must be used to cover their failure to deliver securities) is virtually non-existent.  There are several logical reasons why an AP might have to delay delivery.  One of the most basic reasons is that an international market might be closed when international ETFs in the US are open for trading.

    Now let’s talk about secondary market trading.  ETFs make up a relatively high volume of trades (about 23% of daily trades in the US), so it stands to reason that they’d represent a higher proportion of failed settlements.  Also on the secondary market, you have market makers who are permitted to settle on T+6 in order to facilitate their role in creating fair and efficient markets, which might be skewing the data.  Unfortunately, the failed trade reporting we see doesn’t differentiate between the age of the fail or the entity involved, it just notes the event. Given that, we have to question the validity of the data used in this report.

    I completely agree with the premise that we should eliminate logical risks wherever we can.  ETFs are subject to the same SEC settlement rules as any stock in the equity market (the report mistakenly claims they are not).  So if the SEC wants to create stricter guidelines and punishments for ETF settlement failures, they can, and I might even agree that they should.  But first, I’d want to spend more time fixing the failed trade reporting and analyzing that data to see if something is even wrong.  I’m pretty sure there is a “Contact Us” link somewhere on our website.  Maybe someone at the Kauffman Foundation should make use of it before they release their third report.

     

    Carefully consider the iShares Funds’ investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds’ prospectuses, which may be obtained by calling 1-800-iShares (1-800-474-2737), or by clicking the Prospectuses link. Read the prospectus carefully before investing.

    Investing involves risk, including possible loss of principal.

    The iShares Funds (“Funds”) are distributed by SEI Investments Distribution Co. (“SEI”). BlackRock Fund Advisors (“BFA”) serves as the investment advisor to the Funds. The iShares Blog contributors are affiliated with BlackRock Fund Distribution Company (“BFDC”), which assists in the marketing of the Funds. BFA and BFDC are affiliates of BlackRock Institutional Trust Company, N.A. (“BlackRock”), none of which is affiliated with SEI.

    The strategies discussed are strictly for illustrative and educational purposes and should not be construed as a recommendation to purchase or sell, or an offer to sell or a solicitation of an offer to buy any security. There is no guarantee that any strategies discussed will be effective. The information provided is not intended to be a complete analysis of every material fact respecting any strategy. The examples presented do not take into consideration commissions, tax implications or other transactions costs, which may significantly affect the economic consequences of a given strategy.

    The information provided is not intended to be tax advice. Investors should be urged to consult their tax professionals or financial advisors for more information regarding their specific tax situations.

    Neither BlackRock Institutional Trust Company, N.A., and its affiliates nor SEI and its affiliates provide tax advice. Please note that (i) any discussion of U.S. tax matters contained in this communication cannot be used by you for the purpose of avoiding tax penalties; (ii) this communication was written to support the promotion or marketing of the matters addressed herein; and (iii) you should seek advice based on your particular circumstances from an independent tax advisor.

    This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any security in particular.

    Mar 08 2:18 PM | Link | Comment!
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