As the world has become flatter due to the effects of globalization, investors have felt pressure to diversify beyond their domestic markets. Most financial firms met this demand by offering assets registered in multiple jurisdictions, however, this was usually only for non-discretionary programs.
Sponsors have recently been adding global capabilities to their managed account products as well such as multi-currency, F/X hedging and trading in foreign ordinaries. Along with these expanded offerings comes additional layers of complexity.
This article is a summary of a panel session from the Money Management Institute’s Fall Solutions Conference that was held in October 2013 in New York City. The discussion covered the benefits and challenges of expanding managed account programs to meet the needs of global investors. It also covered some of the latest developments in the highly specialized marketplace for Depository Receipts (DR’s), American Depository Receipts (ADR’s) and Global Depository Receipts (GDR’s) and the impact of fungible trading on the managed accounts space.
- Hanna Salvatore, Director, Mainstay Investments
- Angelo Fazio, Managing Director, BNY Mellon
- Philip Shipper, Director, Merrill Lynch Managed Account Advisors
How large is the ADR universe and what are some of the advantages?
Within the last five years, the number of ADR’s issued by banks has skyrocketed to over 3,700, Fazio reported. (Based on a quick check I did on ADR.com, which is run by JP Morgan Chase, there are 3,853 depository receipts currently active) Some of the advantages of ADR’s are that they are denominated in US dollars and trade during US market hours, he said.
According to Salvatore, when sponsor firms need international exposure, they often use ADR’s, since most firms still track their managed accounts in USD denomination. There can be liquidity problems when dealing with smaller, OTC ADR’s, since they do not offer the same liquidity as larger issues, she responded.
For this and other reason, managers shouldn’t just throw their models over the wall, Salvatore continued, they should also provide instructions to the sponsor about the trading of individual securities. A phone call to the sponsor’s trading desk can be invaluable for gathering feedback on execution. This data can be critical for managers to avoid working against the sponsor when a product is traded on several different platforms, she said.
ADR’s also have lower trading costs and better liquidity than foreign ordinaries, which is helpful when purchasing small positions, Salvatore noted. Some sponsors require high minimums when trading foreign ordinaries and the commissions and fees are higher, both impediments to using them, she pointed out.
However, foreign ordinaries are often the only option for exposure to overseas companies when ADR’s are unavailable, Salvatore stated. She emphasized that when trading them, it is important to communicate early in the day while local markets are still open. Firms that do not have experience trading on foreign markets would do better stepping out of the trades and passing them to an institutional manager, she said.
What are some of the concerns when buying foreign securities directly?
If a portfolio manager wants to purchase shares directly in a foreign market, the same decision points needs to be covered, Shipper insisted. Scale is important since working odd lots can be difficult. It would be easier for an overlay manager who is handling 10-15 strategies since they would have greater order flow available to them, he noted.
Robust data sources are also required when dealing with foreign securities, Shipper continued. Stale pricing should be avoided in order to ensure that you are using accurate values for trading and billing. Another concern is that foreign shares aren’t eligible to settle through DTCC, since there is not enough retail demand in the US, he added.
Foreign governments often have securities rules that are much different than the US, Fazio warned. Russia doesn’t recognize the concept of payment date or ex-dates and in Turkey, short-selling is allowed only on stocks included in the ISE National 100 Index.
Salvatore commented that manager operations can be complicated by foreign holdings tax and trying to resolve recon breaks. Also, additional taxes can be incurred when trades are executed in countries such as France and Italy, she said.
To be successful trading foreign ordinaries, you need to know how to break up and direct orders when there isn’t sufficient liquidity in order to avoid moving the market, Fazio pointed out. If you’re uncertain, check with your broker to find out which issues are thinly traded to avoid out of sync market makers, he advised.
Johnson explained that there were three different touch points for multi-currency support:
- asset positions and fee schedules;
- invoicing of client statements; and
- accounting and bookkeeping records, since assets could come in as Yen, while bookkeeping is in USD and performance reporting in Euros.
How difficult is it to enter the global SMA space?
It is easier now than it was five years ago, Shipper contended. Merrill Lynch was exploring offering an international SMA product, however, their modeling of test scenarios returned poor results. This was because trading wasn’t fungible and there was less cooperation from sponsor firms than they needed, he said.
Is it possible to determine performance attribution for ADR’s?
Accrual information can often be difficult to obtain, but as the data becomes more readily available it will become easier to hold in foreign securities in the local currency without requiring F/X trades back into USD, Shipper answered.