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Diamond Rio PMP300 – Launched in 1998
Three reasons why the ETF industry needs to modernize itself and embrace the benefits of digital factsheets
Published on 7 July 2023
Allan Lane
Allan Lane
Algo-Chain, Co-Founder
In September the world will celebrate the 25th anniversary of the launch of the Diamond Rio MP3 player. While it wasn’t the very first product of its kind, it was the first that caught the public’s imagination. Looking back, with an internal memory of only 32mb, by today’s standards it could barely store more than a few songs. And so it is with all technology, the ‘J’ curve of innovation is so steep, that the third generation of solutions built on the back of those initial products put those initial launches in the shade.

Now let’s think about the evolution of the ETF industry. It still feels as if most commentary about ETFs is from an underdog’s perspective, yet in reality ETFs have been around for quite some time. The industry is ripe for modernization and what better place to start than by requiring all ETF issuers to offer their factsheets in a digital form. Unfortunately for many providers digital means a pdf file, whereas for the data scientist community, the least they expect is that the key facts be accessible via an open API.

For an industry that oversees close to $10tr of assets, it is somewhat surprising how little things have changed during the last 20 years. To illustrate this, let’s take a look at some of the basic aspects of ETF selection and portfolio construction.

The saga of the consolidated tape

If you a user of ETFs then at one time in your career you would have asked ‘how liquid is the ETF that I am looking at?’ and then comes that ah ha moment when you realize in the UK and Europe most ETF trades do not occur on the exchange. As a result, the visibility of the liquidity pool is essentially hidden, so much for the claims of transparency. For many years there has been the saga of the missing consolidated tape, while I gave up on this idea years ago, fortunately many others didn’t.

For those of you not familiar with the idea of a consolidated ETF tape, the basic premise is that it would provide investors with a comprehensive overview of ETF trades on an asset-by-asset class basis, across all trading venues. In the UK and across Europe most ETF trades do not occur via an exchange, and it is this anomaly that makes the ETF eco-system somewhat at odds with itself.

At the recent ETFGI Global Insights Summit in London on July 5th, 2023, Debbie Fuhr had the opportunity to discuss the progress of a plan to establish a consolidated tape with Tilman Lueder, the Head of Securities Markets at the European Commission. The good news is that progress has been made, but the bad news is that the delivery of that pan-European solution could be another 3 years or more away. In today’s fast paced world, where the next AI tech-based revolution might only be a few weeks away, 3 years feels like a lifetime.

Most ETF issuers can’t really influence that debate, but they could modernize their own business model by thinking digital first and embracing the concept of an Open API Factsheet. If you think you would benefit from the insights that a consolidated tape would bring, then surely your data processor needs to also get the underlying analytics.

As an example, the screenshot below shows the details for the iShares Core FTSE 100 UCITS ETF provided by iShares’ website. This includes basic information such as the fund’s management fee and the assets under management. This data is often very accessible, but the more technical aspects of the data set, such as P/E ratio (price to earnings) or the 12m trailing yield, less so.

Why don’t you use a language scraping method, you may ask. Yes, that is possible, but my point is, why should every investment manager hire a person sufficient in python or any other programming language when ETF providers could make it so much easier for the community. Plus, the scope for errors isn’t negligible. It is also worth noting, increasingly, many AI tools are being used to extract data from large numbers of PDF files.
iShares Core FTSE 100 UCITS ETF provided by Blackrock
Managing concentration risk

If there has been one hallmark to the first 6 months of 2023, it has been the dominance of the handful of stocks that have driven the very strong returns of the S&P 500. As a corollary, there have been far more underperforming stocks than one maybe realizes. Exactly how many of the ETFs in my portfolio contain the chipmaker Nvidia as one of its Top 10 holdings? One would be surprised and given the dominance of the supertrend in tech stocks might continue, one needs to take the potential for hidden concentration risk in one’s portfolio seriously.

Perhaps not surprisingly the top 10 holdings of that Internet ETF include names like Tencent Holdings, Alibaba and Baidu, which is exactly what we would expect from a fund providing exposure to the largest tech firms in China. In truth, calling all of these firms as ‘tech’ companies isn’t correct, whereas categorizing them as ecommerce firms might more accurately capture the Zeitgeist of today.
There has been a very strong level of demand for Fixed Income ETFs
How much exposure to Nvidia do you have in your portfolio?
While many data vendors do provide the detailed holdings of an ETF, this has always been an expensive pastime, and many small investment managers cannot justify paying for access to this data. Again, providing a superb opportunity for all of the ETF issuers to provide an API gateway to the full set of holdings.

Selecting Fixed Income ETFs

Not only has Q1 2023 seen surprisingly strong large cap equity index returns, but this also has coincided with a very strong level of demand for Fixed Income ETFs. If you thought it was hard knowing which Equity ETFs take your fancy, wait until you sift your way through hundreds of Fixed Income ETFs.

In many ways none of us should be surprised by this resurgence of interest, after many years of a no/low rates policy, and multiple rate hikes during the last 12m, most of the bad news in Fixed Income assets is behind us. You could say, normality has almost returned. Not so fast though, only a few days ago, the USD yield was at its most inverted in over 40 years!

I’m not sure I want to be selecting Fixed Income ETFs without knowing what the duration of the fund’s interest rate risk is. Hard to believe, but rumour has it that BlackRock has made a large part of its fortune since the Global Financial Crisis of 2008 by selling the capabilities of its Aladdin system. It seems most other shops haven’t been unable to calculate interest rate, credit and inflation risk for a portfolio of Fixed Income securities, so they have mopped up the business where others fear to tread.

Locking in your customers

Joking aside, the only place to easily get access to the Fixed Income risk analytics for any bond-based ETF is from the portfolio manager, thus relegating any 3rd party data provider to play the role of the middle man. Yet again for this reason, any ETF issuers that offer these analytics via an API will win over many new friends.

Microsoft built most of their business by locking in their customers by getting them addicted to some of the tools that came with the operating system, Excel being one of the best examples. Likewise, ETF providers could do the same if they choose to modernize their offering and took the leap and offered their own data via an Open API. Tell me when your launch is, and I’ll be there ready and waiting.

Until next time.

Allan Lane