“The beauty of ETFs is that you can have effectively a rules-based strategy at low cost” says Laurent Kssis, head of CEC Capital, in discussion with Ernst Knacke, Head of Research at Shard Capital in our May outing for Off the Record, the ETF Express podcast series, brought to you in partnership with Truss Edge, providers of front, middle and back-office software and services to ETF issuers. The pair discuss the institutional and wealth approach to using ETFs.
“The beauty of ETFs is that you can have effectively a rules-based strategy at low cost” says Laurent Kssis, head of CEC Capital, in discussion with Ernst Knacke, Head of Research at Shard Capital in our May outing for Off the Record, the ETF Express podcast series, brought to you in partnership with Truss Edge, providers of front, middle and back-office software and services to ETF issuers. The pair discuss the institutional and wealth approach to using ETFs.
Beverly Chandler
Hello, my name is Beverly Chandler and I'm managing editor of ETF Express and I welcome you to the latest edition of Off the Record, the podcast about all things ETF brought to you by ETF Express in partnership with Truss Edge, providers of front, middle and back office software and services to ETF issuers. This iteration of Off the Record brings you Ernst Knacke, Head of Research at Shard Capital, talking about the firm's use of ETFs within an institutional and wealth setting. And Laurent Kssis, head of CEC Capital and a 19 year veteran of the ETF industry, known for trading with leading delta one firms. Ernst I'm going to start with you, if you could tell me about Shard Capital, the client base and the split between high net worth institutional investors and sort of average portfolio sizes that you deal with.
Ernst Knacke
Yes, firstly, Beverly, thank you very much for for having me on the podcast. It's a fascinating topic and and one I I I've become passionate about quite quite significantly in in recent years. So, Sharp Capital started off just over a decade ago as a corporate finance brokerage business and over time it's transitioned from this fee based model to the annuity type model where they offer asset management services. They launched a very successful venture capital business about six years ago out of out of Dublin. They have a a private credit business here in London and about three years ago they they decided to take a step into the investment management, private client family office world, and I joined them from what was Quilter, Quilter investors. And joined the team really to set up the investment process and after that, you know, head up the research function.
Beverly Chandler
And just tell me a little bit about, actually let's go straight to Laurent, and you tell me a bit about your experience in the ETF industry.
Laurent Kssis
Sure. Thanks, Beverly, and thanks for having me on this podcast. This is a very great opportunity to talk about my one of my favourites subject. So I embarked in the ETF world when I was at State Street bank back in 20, 20, back in 20, 2000. And then I was doing portfolio trading which was very much helping institutional investors to book day, what's called really basket orders on the close, which led to managing large sums of money for passive strategies, which led very quickly to looking at what these passive strategies are and most of them came from ETFs, at least they were starting, so we ended up speaking with a lot of issuers. And then I very quickly became involved in the market making of these ETFs. They were still very young around 2005, 2006. I ended up working for a German bank called HVB. They were the leaders in the Indexchange product. Some of the first one that came to market in the European scene for institutional investors that were fixed income. And then I became a fully fledged market maker, so delta one trader for the ETF industry, worked for companies like LaBranche and Bluefin, where we built up an institutional based client facing OTC markets and liquidity providers. And then I embarked into the world of cryptocurrencies where I'm still actively involved in that space with launching crypto structures on the market.
Beverly Chandler
And Ernst what I wanted to ask you was within your Shard Capital role, how much do you use ETFs and or when did you start using ETFs?
Ernst Knacke
So when when I joined Shard Capital, one of the the key, the key foundations for launching our our services was the launch of a subsidiary called Leaf Bridge. And and Leaf Bridge at Target Market is is US expats initially in, in in the UK but really anywhere in the world. And due to the US tax regimes, it it is, you know, effectively you are forced to invest in into US domiciled funds for, for, for US investors outside the US. And the ETF structure from that perspective makes significant amount of sense. And so so we really got involved from day one really with with Leaf Bridge being the first step for Shard Capital into that market and it's it's really you know, a lot of my focus has been on US domiciled ETF's, but you know, as I've got gotten more and more interested in the market, obviously it's, it's transpired into into the European domiciled vehicles as well.
Beverly Chandler
And when would you use ETFs over another vehicle?
Ernst Knacke
I I would say whenever we can. There there's a few instances where it it does not make sense, from from my perspective liquidity risk is is a key factor, I I believe. But but generally speaking, if it's if, if the two investment propositions trade pari-passu, you know there's no difference between the two you would you would use the ETF. And in the US the the US market, the advent of semi-transparent ETFs I think is a is a significant change for, for for that world. And you know the 40 act market generally I think will will undergo significant change over the next, over the next decade.
Beverly Chandler
And Laurent, do you want to comment on that? Is that your experience of how people arrive using ETFs?
Laurent Kssis
Sure, thanks Beverly. So basically the the beauty of of of exchange traded funds is that they are first and foremost low cost products, right? And thanks to their unique structure, you literally looking at a rule based strategy that you, you know, you can have running much cheaper than if you were to invest in a basket of stocks. So for retail investors, you know, you really are struggling buying a a list of stocks because your broker will probably charge you quite a lot on on the custodian. So by having one share of a of a, let's say, a FTSE 100, you get instant exposure to the FTSE 100 universe and that reduces costs tremendously, and they are beautiful products for for for that purpose because not only they are cheap to invest, but they are a basket of stocks so you can have exposure to a whole kind of universe, hence just mentioned the US market. So for any UK investors, they get instant exposure to the US market. They may not know all of these stocks, but the nice thing about it is that it provides diversification, so you may know your top ten, you may know maybe one in the middle and one at the bottom of the list, they’re usually market cap weighted. So it gives you a very decent exposure to the to the market and for a retail investor this is it's it's a great vehicle to use and often misunderstood. Because people believe that, you know, when a market goes down, the ETF goes down and then they, they say, well, it's the fault of the ETF, but it's not. It's the fault of the underlying asset that the ETF holds and that's the vehicle that drives really the performance of that product. So obviously you want to be buying thematics, you want to be buying precious metal, you want to be buying fixed income, and these ETFs allow you to do that. So for me they they they're great products, there's a lot on the market. I mean sometimes there's there's an abundance of of ETF available and it's difficult for the investor to select the right one. But ultimately, if you receive a pot of cash and you're not quite sure what to do with it, you don't want to have single asset exposure, an ETF is a great product to use.
Beverly Chandler
And do you think that, come coming back to you Ernst, are there unique risks to investing with ETFs as an investment instrument?
Ernst Knacke
You know, definitely I, I I I have to say from from a passive perspective, I am I am a believer in in active management. So so you know there there is reasons why one need to understand that the purpose and the objective of of your investment, often it makes sense for for larger institutional clients to use these ETF products. And you know if timing is is a concern then, then of course, you know, ETF makes sense. In a specific to the ETF structures I think there's a few basic rules. You know, investors should use limit orders. I don't think they should necessarily try and avoid buying and selling at market open or at market close, let the price settle. So those are a few, you know, basic kind of rules, you know 101’s, when it comes to ETF investing. But I think the biggest risk is probably liquidity risk. You would you would not put any instruments into the ETF that that is illiquid, you know. So so as soon as the ETF becomes very small or very focused on illiquid markets, that's that is a risk investor should probably stay away from.
Beverly Chandler
And and comment on that for me, Laurent, if you would.
Laurent Kssis
Sure. So Ernst is right, you know the liquidity is a major factor. Remember that an ETF is as liquid as its underlying asset. So you obviously you want to be exposed to a basket of stock or fixed income that are liquid from the start. And you want to be also agreeing with market participants, such as market makers and authorised participants, who are the people who can buy and and create and redeem these ETFs based on the demand in the market, you want to have solid partners with them. You want to have a partner that can price the ETF intraday at a very tight spread, so when you buy in and buy out, you're not paying a huge a huge spread fee. But at the same time you want to have a liquidity as well that is available, and most of the market makers will be able to do a great job there because they will be very comfortable with getting hedges and exposure to the underlying assets, which is key obviously for the ETF to provide large sums of of units available. And this is what we're referring to, the liquidity aspect, when you and I go and buy these products, you want to be sure that you can come in and out at any time. This is the reason why they call it exchange traded products because they trade throughout the trading hours of the stock exchange and they will be able to mimic the underlying assets that that they hold. So what you don't want to have for instance, is an ETF invested in Japan when Japan is closed because you're going to have a much wider spread, of course, because the market maker will not be able to hedge himself properly and offer you a fair value, so there will be a larger spread and also maybe less of liquidity. So you got to put these into context and you know some of the risk there, all these structures have have risk. Uh, you know, you also have counterparty risk at the same time, but for you know most investors, they understand these risks because they wouldn't be invested in them in the first place. Ultimately, again, you you have products that track various strategies. Some might be, as I mentioned, a basket of stock, but some might be also future strategy, future contract strategy and one needs to be very careful about how this strategy functions. So there's a big risk there because a gold future strategy may give a different performance than a Spot gold ETF strategy and so people need to understand the nuance between the two.
Beverly Chandler
And Ernst, have you felt well supported in your trading and use of ETF's? Because obviously you're doing this on a institutional scale. Do you feel you're getting that support and help and particularly when markets are squeezed?
Ernst Knacke
I think so. You know, we've we've never, we've never run into into specific troubles. I I think a key, a key factor for us is we've really taken advantage of the, in the advent of active ETFs, which is more of a US characteristic again, you know ETFs that does not track a specific benchmark. And and as I mentioned you know with semi-transparent ETFs that have that that have risen over the last couple of years, you know, I think that is a market that will significantly open up the opportunity set for for active managers to to, to enter the ETF market. At the moment, it's only US managers that that that can offer that, but the the, the reality is that if you're if you're well positioned to work closely with the advisor, work closely with your with your issuer, you know the. I I don't, you know, I don't think there's any reason why we we we we need to get a lower standard of service or a better standard of service necessarily it's it's about just doing the work and and understanding understanding the product.
Beverly Chandler
And that was going to be my next question was that, with whether you considered the ETF issuer, is that a factor in your screening process? You know, do you have a concern about the probity of the ETF issuer?
Ernst Knacke
It's definitely not a factor in our screening process. At the moment, you know, the the world of active ETFs is is still fairly small and and and growing. So we can go through through these ETFs almost one by one. But the reality is, you know, if you find an issuer or you find an adviser to the ETF that you've never heard of before, or something new in a in a prospectus, then then you would have to look a little bit deeper into it. It's not a it's not a screening criteria, and there's never a blanket yes or no. But you know, if you come across a familiar name that you've done due diligence on in the past and it's a, it's a well recognised institutional participant in in the industry then, then you can probably safely say it's it's safe to move on.
Beverly Chandler
And you've referred to the semi-transparent structure, which obviously is only available in America, but have you found that's worked well for you when you've invested in products that have it?
Ernst Knacke
Yes, yes. Now it's look it it comes with a different set of risks, especially but but that is those risks are are mainly carried by the market makers and the authorised participants and and as a result when you when you do buy and sell in in the in the active semi-transparent ETF, you will often find a slightly bigger spread. But it's still, you know, it's still tiny compared to what you would pay for, you know, relative to say, a management fee or an OCF in in the traditional kind of mutual fund market.
Beverly Chandler
And and for you, that's a good solution for giving you access to a fund manager who doesn't want to reveal the secret sauce, is is that the thinking?
Ernst Knacke
That's that's exactly the thinking. You know, I'm I'm not sure if the, the stocks a manager is buying and selling is necessarily competitive advice, a secret sauce. Its how they get to that point, right? That that is, that's obviously where their competitive advantage sits. And I I've met many people that say that semi-transparent, or the lack of transparency is not a requirement for them, even though they are active managers. But the by far the majority of the active management market would would you know, they believe that not showing the market on a day-to-day basis what they're buying and selling is their secret sauce. And and as such you know this change in the rules by the SEC I think will open up a significant universe for for active managers to to really enter this ETF space. And you know, there's significant benefits to us and our clients from a cost savings perspective, from a liquidity perspective, from a from a transparency or a price transparency perspective, ease of access. So so generally speaking, I I definitely think it's it's a good, it's a good step forward.
Beverly Chandler
And Laurent you mostly work in Europe, so I don't know whether you want to comment on semi-transparent ETFs, but have a go if you wish.
Laurent Kssis
One of the thing Beverly, that we're seeing certainly is, I mean, Ernst is completely right. The the US market offer, these semi active strategies wrapped into an ETF and we're going to see a lot more coming into the market soon and certainly in Europe. And at the moment I understand his his concern that, you know he has to go to the US to get, you know, decent exposure to a semi active product. But the beauty again from an ETF is that they're low cost. So the reason why they do invest in such products is because they are able to offer, you know, a decent performance, semi-actively managed, decent transparency. Also, you've talked about the the probity of of the issuer. You know we also feel that this is very important because an issuer is an active fund manager who has a very good track record, will charge obviously a higher amount, so you know launching an active strategy in an ETF wrapper will have to be considered much lower in terms of cost, right? Because that's what these products are designed to to offer investors. So it's nice to see that at the moment this market is is evolving and we're seeing a lot more active management coming into this space, and also that is going to have a result in in price compression. So I reckon we're going to see a lot more coming into Europe because there's a lot of investors who have very good, very decent and transparent active strategy that we want to wrap into an ETP because the name of the game here is AUM, right? If you're going to launch an ETF and you don't reach critical mass, then your your ETF may not be commercially worthwhile. So you want to have a good strategy, you want to have good market makers in difficult times, and at the same time you want to have probity with the ETF issuers.
Beverly Chandler
And let's just turn to crypto ETPs I think right there, which is perhaps not not quite the place you want me to start, but Ernst do you use crypto or digital asset ETPs?
Ernst Knacke
We we we have not, we we've not gone down that route to to be honest, Beverly. It's it is a very interesting space. I think the the digital asset markets are are are very attractive you know from a long term innovation perspective. We're not sure who's the winners and who's the losers. We're not 100% sure what is the best way to maximise the opportunity. So. So from that perspective, we have not, we've not taken any exposure into any direct cryptocurrencies or or any of the players within that ecosystem. I'm not I'm not sure whether we would go down that route if we buy a cryptocurrency an ETP makes sense. But at the same time a lot of our investors, you know, we would probably recommend them to open a wallet and and do it themselves. You know you know that that's also a a route to access if you're.
Laurent Kssis
But that's the challenge, Ernst. You see, that's, you know, asking your, your investor, who knows very little about what a wallet is, you know, might might complicate the matter even worse. And then they might say, listen, this is too hard for me I'm not going to touch it. An ETP actually offers that solution. You don't have to worry about it. The issuer takes care of all of it, all the risk associated to creating opening a wallet is going to be given to you at a premium obviously, but it will be there for you and this can be done in an ETP wrapper in Europe.
Ernst Knacke
I completely agree. I completely agree. I I guess you know, I was speaking about if you manage money for a family office, you know, then then they just have to open up one wallet and it's one client with, you know, a couple of, you know, tens of millions. But when you go into the wholesale market and you manage your model portfolio for, you know hundreds of clients following the same model, then definitely the ET ETP structure makes, makes complete sense.
Laurent Kssis
I’m just going to complement what what Ernst was saying, we we're in touch with many family offices who've had actually this experience of opening wallets and they find it quite daunting. I mean it's it's a huge risk for them. You know, you have to have internal controls, you've got to report to the board because anyone could go rogue with with, with a wallet. With an ETP you see not only we take care of all of this as an issuer, and at the same time you're getting a a pretty decent strategy. So there's quite a lot of products out there in Europe. Obviously Europe is leading the way much more than the US on that front, mainly because of regulatory challenges you see in the US. But in in Europe you have, you know, multitude of issuers, a multitude of single assets and basket strategies. And I wouldn't be surprised if before long we're going to see active strategies in the crypto space too.
Beverly Chandler
And we, I'm sure we are. In fact I had we do have, don't we? I'm certain you'd be behind them though, if they we did have them so you must know.
Laurent Kssis
There's one in Switzerland today yes, but it's it's not really getting the credit it deserves.
Beverly Chandler
Ohh well that's so weird that. Right here, you heard it here first. I'm going to finish and we've got a few minutes left, I'm just going to ask you, first of all Ernst, you still hear this sort of cry from the traditionalists saying that ETFs could be the cause of systemic collapse in the markets. I mean, do you think that is the case?
Ernst Knacke
I I I don’t I would not necessarily blame ETFs for for the systemic risk. I I I do believe that the risks are there, but it's it's more a function of I I guess a one-sided trade and and, it's more the growth of passive investing rather than specifically ETF investing and the the the traditional mutual fund market, passive mutual fund market is is the same size as the ETF market, right? So there's trillions and trillions of dollars invested into into index funds, that's that is, some traditional structures. So so I I think the risk is is in is in the passive allocation and how the market manages the liquidity and price discovery when when when all of a sudden everyone realises they have to kind of sell their S&P 500 exposure. You know, if that happens at the same time, I mean price discovery will fall off a cliff and you can imagine the outcomes. But that's not necessarily an ETF characteristic, and and the beauty of an ETF, one could argue, is the fact that you can you can exit significantly quicker, right? There's multiple kind of valuation points during the day. You can go on to the secondary market, you can sell your exposure and move on. Where within traditional mutual funds of course its priced once a day and you can execute once, you know once a day it's it's. It is slightly a slightly bigger risk.
Beverly Chandler
And and you Laurent?
Laurent Kssis
Ernst is completely right there because ETFs are proven and tested otherwise you wouldn't be trading them today, right? So this it shows that this market as is worthy of its reputation and they are doing what they say they're doing. Now of course, you know, in volatile markets, you know ETF may actually distort a little bit. And we've seen this right, I mean we've seen this not so long ago with the old contract ETFs where they were negative and that's caused some of the issuers to liquidate these, these these funds and that's not been very good for investors. We've seen it also during the financial crisis in 2008 where you know the likes of high yield ETFs have have actually been under tremendous pressure where as you may know, the the high yield market is driven by investment banks, and if they can't price an investment grade product or a high yield product, the the ETF itself will be distorted. And that's caused a lot of issues to market makers, but I have to say that even during those stress tests and those those severe crisis moments, the ETF has held and has actually grown in size in an area where we, we've seen unprecedented investment. And and again the the the lovely thing about it as Ernst mentioned, is that you can go in and out at any time. But one one thing I will raise though in one of his comments is that yes, if there are many redemption in an ETF that would create, you know, some market discrepancies between the the product and the underlying asset. But you would see this in the mutual fund as well if everyone were to sell at once, right? So at least what we can say is that from an exchange traded perspective ETFs have done exactly what they've been asked to at a very low cost.
Beverly Chandler
Thank you. Thanks for that Laurent. Ernst did you want to add anything final on that and?
Ernst Knacke
No, no, nothing.
Beverly Chandler
He put it well.
Ernst Knacke
Laurent did put it well, yeah did put it well, I think it's a good way to end.
Beverly Chandler
OK, well look, thank you so much to you both for being my guests on our Off the Record from ETF Express, and I want to thank the audience for listening.
Outro
Off the Record is brought to you by ETF Express in partnership with Truss Edge, providers of front, middle and back office software and services to ETF issuers. Production by Imogen Rostron and Lisa Hines and music by Otto Balfour. Thank you to our guests on this episode of Off the Record from ETF Express and to you for listening. We look forward to you joining us next time.