BlackRock has launched a synthetically replicated S&P 500 ETF in a significant policy U-turn that sees the asset management titan lend credibility to an ETF replication structure it previously eschewed, often vocally.
Synthetic ETFs provide exposure to their reference index not by physically holding the underlying index securities but by entering into a swap agreement with a counterparty, usually an investment bank, to receive the performance of the index.
The popularity of the synthetic structure declined sharply following the global financial crisis due to concerns over counterparty and liquidity risks – a 2011 survey conducted by Morningstar found that 90% of respondents indicated they were “somewhat” or “very” concerned about synthetic ETFs.
Some of these concerns were arguably whipped up by ETF issuers whose product line-ups comprised solely or mostly physically replicated products (many of which, incidentally, were at the time lending out portfolio securities and keeping much of the proceeds for themselves) and by traditional fund managers who saw it as an opportunity to attempt to taint the ETF industry.
BlackRock was noted for its championing of physical ETF replication. In 2011 its then Head of iShares in Europe, Joseph Linhares, told the FT that, “ETFs started out as transparent, liquid, simple, vehicles but some have gone to opacity. We need to get back to full transparency across all the range of ETF products.” Larry Fink, the firm’s co-founder and CEO, regularly told investors and commentators that swap-based ETFs lacked transparency and risked damaging the industry.
As a result of all this, many issuers, such as Lyxor and Deutsche Bank, among others, converted swathes of synthetic ETFs to physical replication. This was despite the swap-based structure delivering many noteworthy advantages and ignoring the fact that these products were often over collateralized, in some cases with higher quality collateral than the constituents of the target index, and/or had multiple swap counterparties.
In recent years, however, the tide of criticism against synthetic ETFs has waned as investors have become reacquainted with the benefits of the structure’s inherent tax advantages in certain circumstances.
Most notably, non-US investors are required to pay a 15% withholding tax on income received from dividends. As synthetic ETFs do not actually own the underlying securities and owing to the way the swap arrangements are configured, investors choosing the synthetic structure are not liable for this tax, leading to immediate performance enhancement.
According to market analysis by Invesco, which offers a mix of physical and synthetic products, the firm’s synthetically replicated S&P 500, MSCI USA, and MSCI World UCITS ETFs have each outperformed the average of their largest physical competitors by 0.24%, 0.31%, and 0.12% respectively over the 12 months to the end of August 2020.
When looking over the past three years, these figures climb to 0.71%, 0.64%, and 0.18%, underscoring the long-term relative outperformance potential of some synthetic products.
Another advantage of synthetic ETFs is that they typically offer a lower tracking error compared to their physically replicated counterparts, although this benefit is most pronounced when the fund targets illiquid stocks such as emerging market equities.
The low tracking error offered by synthetic products was brought into focus during the Covid-19 market crisis with tracking errors for physical MSCI World ETFs doubling to 0.10% between 31 January and 30 April 2020. In contrast, synthetic ETFs generally maintained their lower volatility relative to the market throughout this period.
These advantages have contributed to synthetic ETFs gaining a greater market share in certain asset class segments in recent years. The $10.7bn Invesco S&P 500 UCITS ETF (SPXS LN), for example, has attracted over $2.4bn in net inflows over the past year compared to net outflows of $1.4bn for the $38.3bn iShares Core S&P 500 UCITS ETF (CSPX LN) over the same period.
In performing its volte-face, BlackRock will no doubt argue that the ETF industry and the wider financial infrastructure have become structurally more sound in the ensuing years and that levels of transparency and disclosure have improved while ETF investors have become more sophisticated. To be fair, much of this is probably true. Nonetheless, it demonstrates that commercial considerations – namely a company’s bottom line – will always influence an argument, as indeed it did back in 2011 and 2012.
The iShares S&P 500 Swap UCITS ETF has listed on the London Stock Exchange in pound sterling (I500 LN), on Xetra in euros (I500 GY), and on Euronext Amsterdam in US dollars (I500 NA).
JP Morgan and Citi will act as swap counterparties with more investment banks expected to enter the fold in the future.
The ETF’s collateral will consist solely of non-dividend paying S&P 500 equities, helping to allay any concerns that the structure might be unsuitable in the event of a default by a swap counterparty.
It comes to market with $100 million in assets under management and matches the 0.07% expense ratio offered by BlackRock’s physically backed S&P 500 ETF.
The post BlackRock makes policy U-turn with synthetic S&P 500 ETF launch first appeared on ETF Strategy.
Mish’s Daily: Step Back to the Monthly Chart on Transportation
Last Friday, I spoke on Women of Wall Street Twitter Spaces and Fox Business’s Making Money with Charles Payne to talk about a key monthly moving average.What…
Last Friday, I spoke on Women of Wall Street Twitter Spaces and Fox Business's Making Money with Charles Payne to talk about a key monthly moving average.
What makes this moving average so important right now is that three of the Economic Modern Family members are testing it. The three members, Granddad Russell 2000 (IWM), Grandma Retail (XRT) and Transportation (IYT), well deserve their status as what Stanley Druckenmiller calls the "inside" of the U.S. economy. In fact, the components of the modern family were put together before we heard Druckenmiller's viewpoint. We have observed how predictive they all are in helping us see in advance the next big market direction. Hence, these "inside" indicators -- right now -- are all sitting just above a 6–7-year business cycle low.
For the purposes of this daily and because we have featured this sector a lot lately, the chart of IYT is a perfect example of this moving average and what to watch for. Except for the brief blip in 2011 when the government shut down, and then again during the pandemic, IYT has sat above the dark blue line for 11 years. Currently, that line sits at the 195 area. The same is true with IWM and XRT, both marginally holding their monthly MAs.
So, watch IYT to either hold, and begin a rally possibly back closer to 220, or for IYT to fail 195, in which case we see the whole market selling off further.
To note, the other family members, such as Sister Semiconductors (SMH) and Prodigal Son Regional Banks (KRE) are still sitting well above the monthly MA. Big Brother Biotechnology (IBB), however, is now trading below it. And not in the family, but still notable, is the REIT sector (IYR), also sitting below it. SPY has the same MA, only that one sits at 310 (a long way off).
Incidentally, junk bonds broke down under this moving average in November 2021. The market has been slow to take junk bond's hint.
For more information on how to invest profitably in sectors like biotech, please reach out to Rob Quinn, our Chief Strategy Consultant, by clicking here.
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Mish in the Media
A business cycle is about 6-7 years - where are the indices now and what should you watch for? Mish discusses this question in this appearance on Fox's Making Money with Charles Payne.
- S&P 500 (SPY): Testing the previous low; 362 support, 370 resistance.
- Russell 2000 (IWM): Broke the June low of 165.18; 162 support, 170 resistance.
- Dow (DIA): Broke June low -289 support, 298 resistance.
- Nasdaq (QQQ): Testing the June low;269 support, 280 resistance.
- KRE (Regional Banks): Relative outperformer; 57 support, 61 resistance.
- SMH (Semiconductors): 187 support, 194 resistance.
- IYT (Transportation): 196 support, 200 resistance.
- IBB (Biotechnology): 112 support, 118 resistance.
- XRT (Retail): 55 support, 60 resistance.
Director of Trading Research and Educationbonds pandemic nasdaq reit etf russell 2000 testing
Playing the infinite game: patient investing
In his 2019 book The Infinite Game, author Simon Sinek describes how taking a long-term view — what he calls adopting an infinite mindset — is critical…
In his 2019 book The Infinite Game, author Simon Sinek describes how taking a long-term view — what he calls adopting an infinite mindset — is critical for success. Although discussed in the context of leadership, the same principle applies to investing, which has historically favored those who take a long-term view rather than react impulsively to the inevitable ups and downs that occur on the path to creating wealth. Of course, while countless investors have demonstrated that the market rewards those who stay the course, the reality is that doing so isn’t always easy. On the contrary, it takes discipline, self-restraint, and patience.
Investors can quickly lose sight of this reality, particularly in the current environment. Faced with record inflation, rising interest rates, and geopolitical unrest, it’s only natural for investors to want to take action. Shifting strategies or pulling out of the market are among the ways that some investors try to insulate themselves from volatility. Yet the reality is that taking these or other similar steps rarely yields the desired outcome over the long term. Patience isn’t just a virtue. We believe it’s an essential ingredient in any successful financial strategy.
Why we believe patience pays off
As a society, we’re constantly bombarded with information that can either scare us or make us feel like we’re missing out. As a result, it’s easy to feel compelled to take steps we believe will safeguard our assets or to try to time the market or cash in on the latest trend. That’s one reason so many investors have shifted from a buy-and-hold mentality in recent years to one that favors trading securities much more frequently. While the desire to buy low and sell high is understandable, it’s virtually impossible to do so regularly without a crystal ball.
In our view, making a conscious decision to be patient is critical, even though it’s challenging. People are often hardwired to seek instant gratification. We want results, and we want them now. As such, we have a strong bias toward taking action to reach a resolution sooner rather than later, even when waiting can be the more prudent thing to do.
Practically speaking, that means that many investors are willing to sell their assets in a down market in the hopes of avoiding deeper losses. Our experience suggests that, in many cases, had they just remained invested, their outcome could have been markedly different. On the opposite end of the spectrum, those same investors are also prone to selling assets that have increased in value far too soon. While there’s nothing wrong with locking in gains, doing so can come at a high cost if it means missing out on a substantial upside.
With investing, taking action for action’s sake can lead to poor outcomes. Exhibit 1 shows the impact of missing the one, five, and ten days in the market with the highest total return for the Russell 1000 Growth and the Russell 2000 Growth over the past 20 years.1 Notably, some of these “best days” can occur during highly uncertain times, such as the challenging market downdraft at the end of 2008, and the tumultuous early phase of the COVID-19 pandemic in 2020. To us, this underscores the difficulty of attempting to time the market and the wisdom of staying invested for the long term.
Exhibit 1: Impact of Missing the Best Days in the Stock Market, August 31, 2002 to August 31, 2022
Source: Bloomberg, as of August 31, 2022
Patience takes determination, resilience, and the confidence to stand by investments backed by careful, fundamental research. To be clear, being patient isn’t the same as being passive. It’s not about taking your eye off the ball and letting come what may. Nor is it about being too stubborn or inflexible to adjust one’s strategy when merited. Instead, the goal is to see past any noise in the market today and to hold steady in pursuit of greater rewards.
For the patient investor, those rewards are possible thanks to the power of long-term compounding. Our research indicates that successful companies plow profits back into their business to promote further growth, which can lead to greater value and higher stock prices over time. Investors who trade in and out of the market, whether driven by fear or to chase returns from the latest meme stock, frequently miss out on that compounding effect and sacrifice substantial long-term growth.
Taking the patient approach
At Polen, we believe that patient investing starts with adopting an owner’s mindset rather than that of a trader. For us, that means taking the time to identify and invest in what we see as the highest-quality companies and having the discipline to maintain those positions over the long term. We carefully study each company we invest in, engaging with their management teams and examining multiple aspects of their business before allocating capital. We take a bottom-up approach focused on understanding the business, its potential for profitability and growth, and any risk factors that could stand in the way.
Notably, the companies we invest in aren’t new, untested, or at the forefront of the latest fad or trend. They are proven, established businesses with robust balance sheets and the financial flexibility to keep investing in and growing their business in any environment, including periods of high volatility and recession. Once we’ve invested in a company, we continuously monitor its progress and note any factors that could prompt a change in our outlook (Exhibit 2). We believe that this measured, unemotional approach is critical not only for capital preservation but also to position ourselves to reap the full benefits of long-term compounding.
Exhibit 2: Select Factors That May Prompt a Polen Capital Decision to Sell an Equity Security
Source: Polen Capital
While no business is immune to macroeconomic conditions like the ones currently affecting the market, we believe short-term fluctuations shouldn’t be cause for concern. We believe that investors with a diversified portfolio of companies with outstanding fundamentals should reflect that while the path to wealth creation may be bumpy, the patience to play the infinite game can improve one’s chances of succeeding.
1 The Russell 1000® Growth Index is a market capitalization weighted index that measures the performance of the large-cap growth segment of the U.S. equity universe. It includes Russell 1000® Index companies with higher price-to-book ratios and higher forecasted growth values. The index is maintained by the FTSE Russell, a subsidiary of the London Stock Exchange Group. The Russell 2000® Growth Index is a market capitalization weighted index that measures the performance of the small-cap growth segment of the U.S. equity universe. It includes Russell 2000® Index companies with higher price/book ratios and higher forecasted growth values. The index is maintained by the FTSE Russell, a subsidiary of the London Stock Exchange Group. The volatility and other material characteristics of the indices referenced may be materially different from the performance achieved. In addition, the composite’s holdings may be materially different from those within the index. Indices are unmanaged and one cannot invest directly in an index.
This information is provided for illustrative purposes only. Opinions and views expressed constitute the judgment of Polen Capital as of September 2022 and may involve a number of assumptions and estimates which are not guaranteed, and are subject to change without notice or update. Although the information and any opinions or views given have been obtained from or based on sources believed to be reliable, no warranty or representation is made as to their correctness, completeness, or accuracy. Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice, including any forward-looking estimates or statements which are based on certain expectations and assumptions. The views and strategies described may not be suitable for all clients. This document does not identify all the risks (direct or indirect) or other considerations which might be material to you when entering any financial transaction. Past performance does not guarantee future results and profitable results cannot be guaranteed.recession pandemic covid-19 ftse small-cap russell 2000 interest rates
Druckenmiller: “We Are In Deep Trouble… I Don’t Rule Out Something Really Bad”
Druckenmiller: "We Are In Deep Trouble… I Don’t Rule Out Something Really Bad"
For once, billionaire investor Stanley Druckenmiller did…
For once, billionaire investor Stanley Druckenmiller did not say anything even remotely controversial when he echoed what we (and Morgan Stanley) have been warning for a long time, and said the Fed's attempt to quickly unwind the excesses it itself built up over the past 13 years with its ultra easy monetary policy will end in tears for the U.S. economy.
“Our central case is a hard landing by the end of ’23,” Druckenmiller said at CNBC’s Delivering Alpha Investor Summit in New York City Wednesday. “I would be stunned if we don’t have recession in ’23. I don’t know the timing but certainly by the end of ’23. I will not be surprised if it’s not larger than the so called average garden variety.”
And the legendary investor, who has never had a down year in the markets, fears it could be something even worse. “I don’t rule out something really bad,” he said effectively repeating what we said in April that "Every Fed Hiking Cycle Ends With Default And Bankruptcy Of Governments, Banks And Investors" "
"Every Fed Hiking Cycle Ends With Default And Bankruptcy Of Governments, Banks And Investors" https://t.co/tfCHZMEkob— zerohedge (@zerohedge) April 16, 2022
He pointed to massive global quantitative easing that reached $30 trillion as what’s driving the looming recession: “Our central case is a hard landing by the end of next year", he said, adding that we have also had a bunch of myopic policies such as the Treasury running down the savings account, and Biden's irresponsible oil SPR drain.
Repeating something else even the rather slow "transitory bros" and "team MMT" know by now, Druckenmiller said he believes the extraordinary quantitative easing and zero interest rates over the past decade created an asset bubble.
“All those factors that cause a bull market, they’re not only stopping, they’re reversing every one of them,” Druckenmiller said. “We are in deep trouble.”
The Fed is now in the middle of its most aggressive pace of tightening since the 1980s. The central bank last week raised rates by three-quarters of a percentage point for a third straight time and pledged more hikes to beat inflation, triggering a big sell-off in risk assets. The S&P 500 has taken out its June low and reached a new bear market low Tuesday following a six-day losing streak.
Druckenmiller said the Fed made a policy error - as did we... repeatedly... last summer - when it came up with a “ridiculous theory of transitory,” thinking inflation was driven by supply chain and demand factors largely associated with the pandemic.
“When you make a mistake, you got to admit you’re wrong and move on that nine or 10 months, that they just sat there and bought $120 billion in bonds,” Druckenmiller said. “I think the repercussions of that are going to be with us for a long, long time.”
“You don’t even need to talk about Black Swans to be worried here. To me, the risk reward of owning assets doesn’t make a lot of sense,” Druckenmiller said.
Commenting on recent events, Druck was more upbeat, saying “I like everything I’m hearing out of the Fed and I hope they finish the job,” he said. Now, the tightening has to go all the way. “You have to slay the dragon.” The problem is that, as the BOE demonstrated with its QT to QE pivot today, it's impossible to slay the dragon and sooner or later every central banks fails.
What happens then? According to Druck, once people lose trust in central banks - which at this rate could happen in a few weeks or tomorrow - he expects a cryptocurrency renaissance, something which may already be starting...
... and not just there, but in the original crypto - gold - as well...
Excerpts from his interview below:
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