Sign up today and take advantage of member-only content — the kind of timely, cutting edge industry insight that only Money Management Executive can deliver.
  • Exclusive Online Only Content
  • Free Daily Email News Alerts
  • Asset Management Blogs

Innovating in Pricing of International ETFs


PALM DESERT, Calif.-The combined assets of the nation's 956 exchange-traded funds surpassed $1.03 trillion in February, by the tally of the Investment Company Institute.

And if all custodians of such funds decide to provide them charge-free, at some point, "mutual funds will have their hands full," Cary Stier, the U.S. managing partner for asset management services at Deloitte said last week at the ICI 2011 Mutual Funds and Investment Management Services Conference.

Exchange-traded funds, of course, only really got off the ground in 1993 when the American Stock Exchange introduced Standard & Poor's Depositary Receipts, which came to be known as "Spiders."

Now, ETFs are subject of constant innovation in what they contain and how they're priced. Plain-vanilla funds based on equities indices have been joined by funds based on fixed-income products and even leveraged derivatives.

That won't let up, Stier said. But it takes constant application.

"Success through innovation doesn't happen through spontaneous combustion," he said. "We must set ourselves on fire."

A new focus: Exchange-traded funds in the United States which contain foreign equities in their mix of holdings.

Rob Haddad, director of evaluated services at Interactive Data's pricing and reference data group, estimated at the conference that roughly 300 of the ETFs tracked have some international stocks in their market baskets.

Which brings up a key question that Interactive Data is trying to help resolve, with technology: "How do you get a good handle on prices of those foreign stocks after local markets close?"

At a breakfast last week at the conference, Interactive Data introduced a Real-Time Fair Value Information Service that will, it says, provide evaluated prices throughout a trading day for more than 15,000 international stocks.

The service, which should be available by the end of June, takes the closing prices of the stocks and then evaluates them during the trading day on the other side of the ocean.

The service will provide a stream of prices that are "evaluated" every 15 seconds based on historic relationships between individual stocks and several market indicators. They are, in effect, adjustments off the previous day's close, in the foreign market.

Past performance provides insight into what might happen if the local market were open and liquid. For instance, on the day of the Japanese earthquake and the tsunami that followed, the Nikkei 225 Index in Tokyo fell 6.2%. But the Standard & Poor's 500 only fell 1.3%. This market data gets fed into the ongoing evaluations of international stock prices throughout the U.S. trading day.

The fair value evaluations, Haddad notes, are estimates of where international equities would likely trade if liquid in an active market, designed to provide market participants with a benchmark to compare against current market prices. Real-Time Fair Value Information will be available in Interactive Data's existing Basket Calculation Service, which provides intraday "indicative" values for different types of exchanged-traded products and market indices.

The indicative values, in the past, have taken prices of foreign stocks at the close of their trading days, then adjusted them using changes in foreign exchange rates, until their markets reopen.

Now, Interactive Data will be adjusting those "indicative values," using slices of data patterns and relationships that reflect how the stocks traded in the past in similar conditions.

The company's tracking of the old and new approaches shows how the pattern information is expected to improve the indicative value information available for ETFs which include international stocks.

This can be charted. A blue line is used to visually indicate "indicative" values without fair value adjustments based on the historical relationships between stock prices, indices, and other factors. A green line gets used to indicate the "fair value" adjustments of the indicative values. And red lines indicate the market price of the ETF.

The pattern information supports users making investment decisions including redemption decisions, as well as sizing up risks associated with different positions.

The fair value information also will be provided through a high-speed global datafeed that can send the values into trading applications and through a browser-based desktop terminal, for trading, research and analysis purposes.

Not being able to monitor the changing values of assets and whether an ETF is underpriced or overpriced is an ongoing operating risk-and regulatory risk. "Getting the price right is a compliance issue,'' said Deloitte Partner Rajan Chari.

Real-time feeds help automate valuation processes that have long been kept in manual fashion, in spreadsheets and other "one-off" approaches to figuring out values, according to April Lemay, a Deloitte principal.