Portfolio transitions, such as changes in manager, investment objective, benchmark or asset allocation, come with a number of risks. In such times of changes, to mitigate these risks, some investors opt to allocate to cash. But this comes with an opportunity cost and potential market impact.
To reduce the opportunity cost, the majority of investors typically seek to maintain market exposure, while at the same time look for flexibility and liquidity to allow for the reinvestment of assets as opportunities arise, or the intended change is finalised.
Transition management can help navigate portfolio transitions and reduce risk.
Global ETF assets under management 1
Launched the first US-listed ETF
Global number of ETF offerings 2
There are a number of options available to investors when implementing a transition, including futures and swaps. However, swaps can introduce counterparty risk, and there are limited futures contracts to choose from outside of major benchmarks - as a result, managers seeking exposure to non-major benchmarks need to use alternative instruments. Similarly, almost all futures contracts are single-country exposures, so a global or regional exposure requires investing in a combination of a number of futures contracts in different geographies, time zones and exchanges.
Exchange traded funds (ETFs) can offer broad exposure or targeted exposure, making it an attractive and useful tool for investors looking to implement a range of investment strategies such as transition management. For example, to reduce the risk of opportunity cost, ETFs can offer investors interim exposure to a targeted segment of the market, rather than having an allocation to cash. This is known as cash equitisation – a strategy which aims to stay invested with minimal risk instead of carrying cash, reducing the likelihood of performance shortfalls.
ETFs not only have the advantages of liquidity, transparency and flexibility; they are also cost-efficient and easy-to-use. A superannuation fund might terminate one of its bond managers and use an equivalent ETF as a temporary home for the assets until a replacement manager is found – which could be weeks or months away. The relative ease in implementing transactions in many ETFs can make this process particularly cost efficient from an investor’s perspective.
The Transition Time Horizon
In a short term transition, investors should consider the greater impact transaction costs may have and weigh this against the opportunity cost that they are trying to mitigate.
Transaction costs for ETFs are typically seen as moderate, but they make ETFs more suitable for medium to long term transitions.
We launched the industry’s first US-listed ETF in 1993 as a cash equitisation vehicle for institutional investors. Since then, institutions remain some of the largest investors in ETFs, with usage continuing to expand across a wider range of investors and investment strategies. ETFs offer investors further benefits – they are low cost, simple, tax efficient and easy-to-access investments.
Understanding ETF Liquidity
One of the main advantages of ETFs is that they offer liquidity from two sources. From the surface, it may be obvious that there is liquidity as defined by the trading volume and bid/ask spread in the secondary market. Beneath this is another source of liquidity in the primary market that may often be missed.
1 Source: Morningstar, as of March 31, 2019.
2 Source: Morningstar, as of March 31, 2019.