Focus on Exchange Traded Funds

Course Programme

Module 1

Unit 1: Learning Aims and Objectives

Knowledge

On completion of this module, the successful participant will be able to:

• Understand the origins of exchange traded products and the rapid adoption by market participants
• Understand the distinctions between exchange traded funds (ETFs) and exchange traded notes (ETNs)
• Recognise the characteristics that distinguish ETFs from other financial instruments
• Understand the dynamics that have propelled ETFs to become the dominant asset class in contemporary markets
• Define the scope and size of the ETF Industry in comparison to other investment products
• Understand the way in which large institutions and hedge funds have adopted ETFs as preferred investment products

Skills

This module will call for the successful participant to:

• Differentiate between different kinds of ETPs
• Explain the factors which have contributed to the success of ETFs
• Contrast the limitations of traditional collective investment vehicles (CIVs) with features of ETFs
• Identify the chief risks associated with holding ETFs

Historical Development Of Exchange Traded Products

• Focus on the SPDR Trust™ created by State Street in 1993
• Review of other collective investment vehicles (CIVs)
• Fee structure and execution benefits of ETFs
• Use of ETFs as part of a reaction to active management strategies
• Behaviour of ETFs during market stress periods – e.g. the Flash Crash of 2010

Case Study

• The original ETF – State Street’s SPY

Footprint of ETPs in Global Capital Markets

• Compare availability and range of ETFs traded on US, European and Asian platforms
• Number of funds, assets under management, growth trajectories
• Regulatory issues for ETF sponsors and investors
• Role of ETFs in institutional investment strategies
• Access to emerging and frontier markets

Case Study

• Compare the performance and AUM of ETFs with hedge funds

ETFs as Structured Products

• Contrast features of ETFs to mutual funds and investment trusts
• Primary and secondary market activities
• Contrast funds which hold “physicals” versus those which are synthetic
• Nature of counter party risk regarding synthetic ETFs
• Regulatory issues concerning structured products e.g. MiFID II

Module 2: Learning Aims and Objectives

Knowledge

On completion of this module, the successful participant will be able to:

• Contrast open ended investment vehicles with closed ended funds
• Demonstrate a comprehensive understanding of the organizational structure of exchange traded funds (ETFs) and exchange traded notes (ETNs)
• Understand the nature of the fiduciary and trust architecture of ETFs
• Importance of fees earned from Securities Borrowing and Lending Intermediaries (SBLIs)
• Treatment of dividends and other income generated in the underlying securities
• Use of derivatives in the ETF creation process

Skills

This module will call for the successful participant to:

• Analyse the role of Authorised Participants in the creation and redemption process
• Understand the role of securities lending as a form of income to ETF sponsors
• Understand the importance of tracking error – deviation from the performance of the underlying
• Explain the difference between different replication strategies – stratified sampling vs. full replication

Organisational Structure of ETFs

• Nature of open ended investment vehicles
• Fiduciary/trust architectures
• Role of sponsors and trustees
• Function of Authorised Participants (APs) in the primary market
• Creation and redemption units – role of APs

Case Study

• Detailed analysis of the creation and redemption process

Secondary Market Features of ETFs

• Market micro-structure issues for ETF trading
• Secondary market characteristics – liquidity issues
• Does the ETF trade at a premium or discount to NAV?
• Treatment of dividends and other income generated in the underlying securities
• Second order trading of ETFs - e.g. contracts for difference (CFDs) that reference ETFs

Case Study

• Importance of fees earned from Securities Borrowing and Lending Intermediaries (SBLIs)

Key Investment Metrics of ETFs

• Expense ratio – the fee structure and how collected
• Market performance – total returns, volatility, correlations
• Replication strategies – stratified sampling vs. full replication
• Tracking Error – deviation from the performance of the underlying
• Issues connected with leveraged ETFs

Module 3: Learning Aims and Objectives

Knowledge

On completion of this module, the successful participant will be able to:

• Describe the size and scope of equity ETs available to global investors
• Explain the overall framework for sector-based equity products – industry, style, geography
• Understand the benefits to investors for targeted access to specific sectors
• Describe the rationale and mechanism behind leveraged equity-based ETFs
• Describe the rationale and mechanism behind inverse equitybased ETFs
• Identify the major inverse and leveraged ETFs available to equity investors
• Explain asset allocation strategies that are widely used by asset managers that use ETFs

Skills

This module will call for the successful participant to:

• Describe the diversity of equity-based ETFs that can be used by asset managers and individual investors
• Identify and analyse the special tracking error issues behind inverse and leveraged ETFs
• Explain the constant leverage trap and how this impacts tracking
• Explain the rationale and mechanics of ETFs that are based on smart beta strategies
• Explain the demise of ETFs that implemented short volatility strategies

Global Equity Indices

• Explanation of the logic and classification of equity indices
• MSCI equity index products
• Review the key US and European index products
• Review of the key ETFs that track emerging market indices
• Review of the key ETFs that track frontier market indices

Case Study

• Examine the significance of SPY as the most widely traded financial instrument in US equity markets

Sector Index Products

• Overall framework for sector-based products – industry, style, geography
• Benefits to investors for targeted access to specific sectors

Leveraged and Inverse Equity ETF Products

• The rationale for inverse ETFs – facilitates shorting of securities
• Claims made by ETF sponsors regarding such products
• Leveraging mechanics for equity-based ETFs
• The constant leverage trap – how does this impact tracking?
• Review of the major inverse and leveraged ETFs available to equity investors

Case Study

• Review the tracking behaviour of some of the main inverse and leveraged ETFs base on US equity markets

Equity Investment Style ETFs

• Review of asset allocation strategies that are widely used by asset managers
• Value style versus growth style
• Diversification styles – geographical and sector diversity
• Essentials of performance attribution analysis
• ETFs which are based on smart beta strategies

Case Study

• Examination of ETFs that implement short volatility strategies including a detailed analysis of the demise of the Credit Suisse fund – XIV

Module 4: Learning Aims and Objectives

Knowledge

On completion of this module, the successful participant will be able to:

• Differentiate between different kinds of fixed income ETFs based on the credit quality of the underlying constituents
• Describe the various ETFs that track sovereign bonds in developed and EM economies
• Provide an explanation and examples of a bond index
• Describe the concerns within the market place regarding liquidity of ETFs that are based on underlying high yield debt instruments
• Describe how to US Treasury based ETFs to trade the US government bond yield curve

Skills

This module will call for the successful participant to:

• Explain the nature of total return as applicable to the fixed income asset class
• Explain how bond-based ETFs have different behaviour to actual bonds
• Contrast between sovereign based bond ETFs and corporate based bond ETFs
• Describe how to impleme

Total Return Fixed Income Products

• Nature of the yield curve – term structure of interest rates
• Total return characteristics – coupon plus capital gain/loss
• Review of US Treasury ETFs
• Special case of zero coupon fixed income instruments
• Explanation of how bond-based ETFs have different behaviour to actual bonds

Case Study

• Using US Treasury based ETFs to trade the US government bond yield curve

Credit Quality Products

• Distinguish between investment grade and sub-investment grade debt instruments
• Explanation of credit quality and credit risk within the fixed income universe
• Contrast between sovereign based bond ETFs and corporate based bond ETFs
• Review of ETFs which track investment grade corporate bond indices
• Review of ETFs which track high yield corporate bond indices

Case Study

• Liquidity issues with ETFs that are based on underlying high yield debt instruments

Examination of the Features and Performance of HYG and JNK Commodity and Currency ETFs

• Overview of the nature of FX markets and different investment vehicles
• Overview of the nature of the commodity futures market
• Review of ETFs which track foreign currencies – how they are constructed
• Review of ETFs which track commodities – synthetic replication

Case Study

• Use case for forex hedging with an ETF that tracks a G10 currency

Module 5: Learning Aims and Objectives

Knowledge

On completion of this module, the successful participant will be able to:

• Distinguish between active and passive investment management
• Examine the philosophy advocated by index tracking e.g. Vanguard’s Bogle
• Contrast the fees typically applied for active management
• Explain the logic behind smart beta – risk factor asset allocation models
• Examination of the performance of various widely used smart beta ETFs
• Describe the regulatory risk to ETFs as policy makers focus on liquidity risk of structed products in contemporary capital markets

Skills

This module will call for the successful participant to:

• Describe the performance of various widely used smart beta ETFs
• Identify and explain ETFs which implement hedge fund strategies
• Identify risks for ETFs based on market capacity issues – especially the underlying liquidity of ETF constituents
• Explain the liquidity risks with ETFs that focus on emerging and frontier markets

Active Versus Passive Investment

• Distinguish between active and passive investment management
• Examine the philosophy advocated by index tracking e.g. Vanguard’s Bogle
• Contrast the fees typically applied for active management
• Using ETFs for diversification within an actively managed portfolio
• Redemption gates and liquidity constraints within hedge funds

Case Study

• Review of historical performance statistics for returns from active and passive fund managers

Smart Beta Strategies

• Explanation of fundamentals of CAPM, risk and reward and beta
• Review of the logic behind smart beta – risk factor asset allocation models
• Examination of the performance of various widely used smart beta ETFs
• Crowding and herding issues with smart beta strategies
• Are the promises provided by smart beta ETF sponsors warranted?

Case Study

• Examination of the model and performance of Vanguard Dividend Appreciation ETF - VIG

Implementing Global Macro Strategies With ETFs

• ETFs which implement hedge fund strategies
• Merger arbitrage strategies
• Long/Short strategies
• Beta neutral strategies
• Managed futures

Special Risks with ETFs

• Special Risks with ETFs
• Market capacity issues – especially the underlying liquidity of ETF constituents
• Liquidity risks with assets in emerging and frontier markets
• Regulatory risk as policy makers focus on liquidity risk of structed products
• Transparency risk with structured products e.g. MiFID II
• Capital controls in frontier markets

Case Study

• Examination of the model and performance of iShares MSCI Frontier 100 ETF - FM