This content is from: Innovation

ETFs are Getting Smarter

Demand is increasing for more nuanced solutions – and the innovators are keeping pace.

Institutional asset managers and wealth advisors have long prized the flexibility of ETFs. In turn, the funds are now evolving to bring more nuanced strategies to market in response to demand from investors. For example, to address inflationary challenges, new actively managed ETF products are using options to hedge the market or provide target outcomes in actively managed fixed income. As is often the case with ETFs, the underlying basket of securities is a crucial element of their success – and the ability to customize that basket is in ever-greater demand. 

“Active management and customization are really starting to gain traction in ETFs,” says Ben Slavin, Global Head of ETF Asset Servicing, BNY Mellon. “Last year, between 7% and 8% of ETF flow was in actively managed ETFs. For 2022, I’m anticipating about 10% -15% of flow going into active on our platform.” 

Slavin observes this and other trends in ETFs from the ultimate vantage point – a platform that puts him and his team at the nexus of ETF creation, strategy, trade execution, custody, and everything in between. To him, the rise in the use of actively managed ETFs signals a comfort level on the part of asset managers and wealth advisors.

“We’re witnessing a convergence of institutional and retail investing, and ETFs have brought an institutional-priced and an institutional-type structure to the retail market,” says Slavin. “That makes advisors more comfortable putting ETFs in their portfolio. Every quarter sees new varieties of ETFs emerge to satisfy demand.” 

The smart basket

A soaring appetite for fixed-income ETFs led Slavin and the team at BNY Mellon to create its ETF Intelligent Basket Builder, which provides a central point of communication between the sell-side and buy-side. The tool facilitates the negotiation, execution, and transmission of creation and redemption orders, saving time and providing greater transparency in the negotiation process. 

In recent history, custom baskets in the fixed-income arena were typically negotiated via Bloomberg chat. Ultimately, the deal would be pushed downstream for processing, creating operational-related risk in a labor-intensive and costly process. 

“The big idea was to bring some automation to that process,” says Slavin. “We have brought the ability to negotiate baskets directly into our platform. When the button is clicked, there’s no latency. Deal information is immediately sent into our core ETF technology to be processed and ultimately moved down the chain to custody for trading and settlement. The other big piece is enabling portfolio managers and dealers to access a common set of market data inside the platform. That’s a big thing in fixed income, where there’s a wide view on pricing and valuing of bonds.”

The growth in fixed income ETFs has been eye-popping in recent years, spurred in part by SEC Rule 6c-11 (The ETF Rule) in 2019, which among other things leveled the playing field regarding custom baskets. Prior to that, only a handful of legacy issuers could customize baskets. Customization makes it easier and more practical to offer a wider range of fixed-income strategies in the market – hence the explosion in fixed-income product development. 

“The Intelligent Basket Builder is designed for fixed-income custom baskets. It brings automation and mass scalability of the platform as the number of products and volume of transactions rapidly increases,” says Slavin.  

All in on tech

BNY Mellon’s commitment to technological innovation reverberates across the ETF industry. All of that is having a downstream impact. “Our technology is not just geared for ETF issuers, but also liquidity providers who are connected to us and are facilitating market-making creation and redemption on behalf of our clients. We view them as an extension of what we’re doing in our platform. Part of what we’re doing is providing a common language directly tied to how the ETF itself values the assets.” 

On the BNY Mellon platform, known as NEXEN, the ETF space has about $1.25 trillion in assets, and has launched on average nearly one ETF per day globally over the past 18 months. Slavin admits that kind of growth is sometimes startling even to him – but it does speak to the way in which BNY Mellon’s many businesses and talents can provide asset managers and advisors with holistic solutions that are not otherwise easy to come by.   

“Given the growth, we’ve significantly ratcheted up our technology spend for the ETF platform,” says Slavin. “The majority of the spend targets automation to remove friction from the ETF market. By that I mean to reduce costs and latency for our asset manager clients, but also serve the market makers and liquidity providers who are the lifeblood of the market.” 

The asset servicing businesses at BNY Mellon are among the largest in the industry, and it happens that Slavin and his team are in a core position to benefit from that reach – which creates contact with ETFs in multiple ways.   

“We have several clients that interact with us at BNY Mellon Capital Markets, through which BNY Mellon itself acts as an authorized participant. So, we are involved in the primary dealing for ETFs for many of our clients. On behalf of the bank, we’re also a liquidity provider or a primary dealer, which gives us a unique lens in addition to asset servicing,” says Slavin.

Also, under the BNY Mellon roof is Pershing, which is many things to many clients. Many ETF issuers work directly with Pershing on distribution and have a direct connection to the financial advisors inside Pershing Lockwood. That in turn provides a view of what’s driving ETF adoption among advisors and on TAMPs.  

These many arms of BNY Mellon are all connected on a single platform, giving Slavin, his team, and their clients a view of and access to the entire ETF value chain, from inception to clearing and custody. 

All of this – the technology, intelligence, scale, access – revolves around ETFs. “There’s a democratic principle embedded into ETFs that I think appeals to almost everyone who uses them,” says Slavin. “Whether you invest $1 or $1 trillion, you get the same price. There are no different classes of shareholders. People gravitate to that.”



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