An edited version of episode 5 of ETF Express’s Off the Record, brings you the fundamentals of ETFs, courtesy of Franklin Templeton’s Jason Xavier, Head of EMEA ETF Capital Markets.
Listen now as Jason explains what is an ETF and how they can be incorporated into your portfolios.
This episode of Off the Record is sponsored by international asset manager, Franklin Templeton.
Capital at risk.
An edited version of episode 5 of ETF Express’s Off the Record, brings you the fundamentals of ETFs, courtesy of Franklin Templeton’s Jason Xavier, Head of EMEA ETF Capital Markets.
Listen now as Jason explains what is an ETF and how they can be incorporated into your portfolios.
This episode of Off the Record is sponsored by international asset manager, Franklin Templeton.
Capital at risk.
Beverly Chandler
Hello and welcome to this episode of Off the Record from ETF Express. This one is about ETFs the fundamentals with Jason Xavier, head of EMEA ETF capital Markets for Franklin Templeton and me Beverly Chandler, managing editor of ETF Express. Franklin Templeton's Global ETF platform has a range of active, factor based and passive ETFs and approximately USD $15 billion in assets under management globally as of the 31st of May 2023. So Jason is here to explain, exactly what is an ETF?
Jason Xavier
Thank you very much, Beverly, and thanks for having me today. What is an ETF? Well, an ETF is effectively a fund. Exchange Traded Fund. So it's a fund vehicle just like a a mutual fund. However it has the extra flexibility of trading on a stock exchange, so the E and the T is Exchange Traded and then Fund as you normally have for a mutual fund. So just like a mutual fund, it's a collection of stocks or bonds. They trade intraday, the ETF trades intraday and at the end of the day you have a net asset value, a NAV of the fund, just like you do for a mutual fund. Again, the flexibility around intraday pricing gives you price discovery as well as cost efficiencies. Low TERs typically are seen with ETFs, and ETFs can incorporate different strategies as you mentioned. So passive, alternative index strategies as well as active strategies. So that's that's an ETF in a nutshell.
Beverly Chandler
And when you say intraday, so explain to the audience what that means.
Jason Xavier
So intraday means that obviously with a mutual fund you effectively have a NAV at the end of the day and it's priced at that NAV at the end of the day. So you can only really buy a mutual fund at the end of day price and once a day, whereas an exchange traded fund allows you to buy the fund at any time during market hours. So just like the stock trades on an exchange, you can buy an ETF at the open, 8:00 AM in the morning, and at any time during the trading day up until 4:30 at the close. So you can transact in a fund, it's the only fund vehicle that allows you to transact intraday, just like you would do a stock. And all the benefits that come with that.
Beverly Chandler
And then tell me when were ETFs invented?
Jason Xavier
So interesting question. ETFs were effectively invented, ETFs were born really out of the 1987 Wall Street crash. You may remember that, the Black Wednesday, markets tanked completely 1987 in the UK as well. It made the news. There's a lot of people in the industry that were not around for that sort of episode but for a few of us, we remember. I grew up in the 80s and I remember the Wall Street crash. After, post that crash, it was really the US SEC that consulted Wall Street to try and figure out how they could allow large blocks of stocks to be transacted in one trade and hence allow large amounts of liquidity in and out of the the system in one trade. So consulting the street, they effectively worked for a couple of years on this and eventually they arrived at what is now the exchange traded fund. So the ability to transact in a portfolio of stocks and now bonds or commodities with just a single trade, and pump liquidity into and out of the system. So kind of acting like a pressure release valve. It's interesting that that, that pressure release valve sort of methodology if you like, has over the last 30 years since ETF's were invented, how time and time again that has been tested. And we've seen that on multiple occasions. The global financial crisis, the Greek debt crisis, the Arab Spring, Brexit, the COVID pandemic, or even the the war in Ukraine, we saw how the ability for portfolio managers and investors to move large equities or bonds in a single trade really acts as a cushion to the markets and allows for liquidity in the system to continue to flow.
Beverly Chandler
And you, you, so you were talking about pumping in liquidity. I mean, perhaps if you could explain what liquidity means in this context for investors?
Jason Xavier
So prior to ETFs, the transaction of stocks was, and still is, a single stock transaction, so you buy and sell a stock and the liquidity is dependent on how many stocks are being transacted and what's the, what's the notional outstanding, how many shares are issued. Now there's a finite number of shares that are actually issued so if you're transacting in any given number of those shares, the liquidity is dependent on what the market is prepared to buy and sell. Now if you, prior to ETFs being around, you could only really do that in a portfolio of portfolio trades, so the buying and selling the stocks on individual lines. The ETF allowed the same transaction to occur, but at a much bigger level, to occur on a much broader portfolio level by not just institutional investors, but all the way down to retail investors. So a retail investor prior to ETFs would have to have their stockbroker buy them the equivalent portfolio, let's say the FTSE 100. Their their portfolio manager would buy a mutual fund or would buy the individual stocks, and with a mutual fund as an example, there would be no intraday transacting from that end investor, their transactions would all occur at the end of the day. So there will be a flurry of activity that will happen into the close as opposed to periods throughout the day. So that liquidity is the ability to allow stocks to be bought and sold and the byproduct of that is is effective liquidity. You're you're allowing things to flow, it's liquid. That's how I look at it.
Beverly Chandler
OK. And so and how does the average investor buy and sell an ETF? It's a slightly different route, isn't it?
Jason Xavier
ETFs are super flexible. So if you take, if you think of an ETF as giving you all of the things you get from a mutual fund plus a plethora of more, you know you you get more. So you get the mutual fund plus. And one of the things that you get is the ability, as I said, to transact intraday on a stock exchange. If you are at an end investor, a retail end investor like myself and yourself, Beverly, if we're looking to buy or sell an ETF, how would you typically do that? We'll go to our online broker or our online SIP platform provider and we will say I want to buy a particular stock and you would look at the platform, they'll give you a bid/ask spread and you'd say I want to buy or I want to sell. In a similar fashion, you have to do the same for ETFs. If I want to buy an ETF, I would go onto my online broker and I would see a buy and a sell and I'd see the bid and an offer. And I would then press the button whether I'm the buyer or a seller and I'd transact in the ETF. That online broker, or my broker, will then go to the stock exchange and effectively buy or sell those stocks and will buy and sell that ETF that I've put an order in for. Now because ETFs trade just like stocks, it gives me the flexibility now to put the order in using a different order type than just buying at the market. I can say that I would like to put a limit order in, so you know I I want to wait until the price goes to a, comes down to a certain level before I buy. If I'm an institutional investor I could use an algorithm to trade my ETFs or trade ETFs. So the fact that you get all the benefits of a mutual fund plus some more, those those really come into play with the way that you can transact an ETF. So your online broker or your broker will allow you to enter, buy or sell an ETF, and if you're an institutional investor then your trading desk will will have the ability to transact. One other thing that's worth talking about is again, you get all the flexibility of a mutual fund plus more, so you can also buy ETFs at the end of day NAV. And not many people realise this that you can actually, if you wanted to you can buy the ETF intraday and you can take the intraday price, or you could say well I just want to buy the ETF just like I would do a normal mutual fund and you can tell your broker I want to buy that ETF at NAV. And you could do that on exchange or you can do that over the counter as well. So if you're an institutional investor, you can also trade over the counter using a request for quote platform or you can do it on exchange.
Beverly Chandler
And what sort of investments can I make through ETFs?
Jason Xavier
So at Franklin Templeton, we've got as you described, we've got a few pillars to our range. So we have five key sort of pillars. We have our fixed income range; we have our single country passive range; we have ESG sustainable range and we have thematic and smart beta range, or alternative index range. Those are some of the examples of different kind of styles of investing in that you can invest in. Now effectively you can use ETFs to invest in stocks, bonds, commodities. You can take a core approach, a tactical approach. You can look to use ETFs for risk management, for liquidity as we described, a liquidity sleeve. We see a lot of people say, well, I have my mutual fund core holdings and if I do need to or want to transact, I'll use an ETF because it gives me that flexibility to trade intraday. So if something's happening in the news and I actually think halfway through the day when I'm, you know, just about to do the school pickup, actually I want to sell some of that holding, well you could do that while you're while you're waiting for the kids to come out. So you can actually do that on your online platform and you can actually make those allocations in real time. Now that, that ability, that liquidity sleeve as I described is another sort of example of the flexibility and how you can utilise the wrapper. So yeah, you can invest in stocks, bonds, commodities. Different styles of investing, be it core, tactical, income, looking for dividends, you can utilise it for that as well. So so much flexibility in the wrapper, which is why it's gaining so much popularity.
Beverly Chandler
And are ETFs safe if there's the moment of sort of market crisis, will ETFs be hit differently?
Jason Xavier
So ETFs are just a fund wrapper and this is what a lot of people don't realise. They are not an asset class in themselves, they are just a fund vehicle, right? So you have a mutual fund that is a fund wrapper; you have investment trusts that are fund wrappers; you have ETFs that are just another version of a fund wrapper. They are just as safe as a mutual fund, if not safer, because a lot of mutual funds, you know when times are in times of crisis we've seen periods where, you know, funds have had to gate or they've stopped redemptions and mutual funds can do that. ETFs are open-ended vehicles that give you mark to market pricing and price transparency. So I’d say to a certain extent that they're they're safe, super safe, safer in some respects because I know that I can transact at any point in the day to react to some volatile news or things that are going on in the market. So you know what does safe mean, can I take my money out? Yes, you can sell intraday. Can I see what's invested in my ETF? Yes, there's full transparency, so you know the the three key benefits of an ETF, the transparency, the liquidity and the low cost nature, is something that really continually sort of gets drawn out in every conversation. When we talk about safety, can I see what's I'm what I'm invested in. Every day you can see that, there's full transparency around that. So yes, super safe.
Beverly Chandler
And can you buy portfolios of ETFs?
Jason Xavier
You can. You can buy, we see a lot of multi asset strategies utilise ETFs and that's very similar to a portfolio of ETFs. Now if you look at a lot of the robo advisors that are growing in market share across Europe, and you know you jump on the tube and you'll see an advert for a few of these. All of these advisors and these robo advisors, the reason they're taking off is because they ultimately fundamentally use ETFs as their building blocks. So they use ETFs to fulfil that low cost, that transparent, and that liquidity feature that we keep describing that allows these robo advisors to build different model portfolios. And depending on your risk profile, you will either be in a high risk model portfolio that will have a certain group of ETFs versus a lower risk portfolio which will have a different makeup of ETFs. But if you look at what they're utilising, they're all ETFs, they're all bond ETFs, equity ETFs and commodity ETFs as well in there.
Beverly Chandler
And if you want to invest sustainably, are there any options to do that through an ETF?
Jason Xavier
Absolutely. So again, as an example, we have at Franklin Templeton, we have a range of sustainable ETFs, we have bonds that are labelled green. Now what does that mean? That means a particular bond is issued for a green project. So a very simple example I always use is a wind farm. A wind farm has company has issued bonds to fund a wind farm that's directly going to obviously contribute to the transition to a green economy. Now this pureplay opportunity is perfect in the ETF wrapper because you have made the conscious decision that you want to invest in the transition to a green economy so you can't wait for, you know, three years track record. So ETFs and index products that track an index that invest in those particular names or those particular bonds gives you that exposure directly. Now in the green bond scenario, obviously we have an active product because the green bond market is quite nascent. So you do need expertise there to actually pick the right green bonds versus other green bonds and ensure that that green label is justified.
Beverly Chandler
And then can you put the green bond ETF portfolio into an ISA? Is that possible?
Jason Xavier
You can. So ETFs are ISA eligible. So you can have them in ISAs, you can have them in SIPs. But again it will depend on your particular broker, your online broker or your platform ensuring that they have those ETFs on the platform for you to invest in, but they are eligible, yes.
Beverly Chandler
OK. Well, thank you so much, Jason. Is there anything else you'd like to add in this quick introduction to all things ETF?
Jason Xavier
No, that's perfect, Beverly, thank you very much and look forward to seeing you soon.
Beverly Chandler
Thank you so much. That was Jason Xavier, who is head of EMEA ETF capital markets at Franklin Templeton discussing the fundamentals of ETFs.
Outro
Off the Record is brought to you by ETF Express. 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.