1 FEBRUARY 2016 | © CME GROUP
EXECUTIVE SUMMARY
• Thisreportcomparestheall-incostofreplicatingtheS&P500totalreturnviaequityindexfutures
andexchange-tradedfunds(ETFs)acrossavarietyofusecasesandtimehorizons.
• ThespecificproductsusedintheanalysisaretheCMEE-miniS&P500futureandthethree
U.S.listedS&P500ETFs:theSPDRSPY,iSharesIVVandVanguardVOO.
• Theanalysisbeginswithadetailedlookatthecomponentsoftotalcostandtheassumptions
thatunderliethecalculations,whichincludesobservationsaboutrecentchangesintheimplied
financingratesoffuturesandthedriversofthesemoves.
• Thetotalcostofindexreplicationacrossarangeoftimehorizonsiscalculatedforfourcommon
investmentscenarios:afully-fundedlongposition,aleveragedlong,ashortpositionanda
non-U.S.investor.
• ThechoicebetweenfuturesandETFsisnotaneither-ordecision.E-miniS&P500futuresare
showntobemorecost-effectivethanS&P500ETFsforleveraged,shortandnon-U.S.investors
acrossalltimehorizons.
• Forfully-fundedinvestors,theoptimalchoiceisafunctionoffuturesimpliedfinancingand
investmenttimehorizon.Whentherollcostoffuturesissub-Libor,investorsareunequivocally
betterservedbyfutures,andiftherollcostisatapremiumtoLibor,themostcostefficient
alternativecouldbeeitherafutureoranETF.
Scenario
Cheapest Option
Roll is Cheap (Below 3-month USD Libor)
Roll is Rich (Above 3-month USD Libor)
Fully-Funded Futures Depends on holding period and degree of richness
Leveraged(2x,8x) Futures Futures
ShortSeller Futures Futures
International Futures Futures
Scenario: Fully-Funded, Roll Cost at a Premium to 3-month USD-Libor
Spread to 3-month USD-Libor
E-mini S&P 500 futures are more cost effective than ETFs for all investors when the Roll Cost trades at, or below, the following holding periods:
30 Days 60 Days 90 Days 180 Days 1 Year 2 Year 4 Year
+51bps +30bps +20bps +11bps +6.3bps +4.0bps +2.9bps
2 FEBRUARY 2016 | © CME GROUP
INTRODUCTION
This report compares the all-in cost of replicating the S&P
500 total return1 via equity index futures and ETFs.
Given the diversity of clients and potential uses for both
ETFs and futures, there is no “one-size-fits-all” answer to
the question of which is more cost-efficient. The optimal
choice depends on the details of both the client and the
specific trade.
The approach is, therefore, to consider four common
investment scenarios – a fully-funded long position, a
leveraged long, a short position and a non U.S. investor –
and compare the costs of index replication with futures
and ETFs in each. While these scenarios do not represent
all possible applications for either product, they cover
the majority of use cases, and analysis of the scenarios
provides insights into factors that investors should
consider when making their implementation decisions.
This analysis compares the CME E-mini S&P 500 future
(ticker: ES) with the three US-listed S&P 500 ETFs: SPDR
S&P 500 ETF (SPY), iShares Core S&P 500 ETF (IVV) and
Vanguard S&P 500 ETF (VOO).
COST ESTIMATES AND ASSUMPTIONS
The goal of this report is to quantify the cost of replicating
the total return of the S&P 500 index over a given period of
time using equity index futures and ETFs. The framework
for analysis will be that of a mid-sized institutional investor
executing through a broker intermediary (i.e. not direct market
access, or DMA) for a hypothetical order of $100 million.
The total cost of index replication is divided into two
components: transaction costs and holding costs.
Transaction Costs
Transaction costs are expenses incurred in the opening and
closing of the position. These apply equally to all trades,
regardless of the time horizon.
Commission: The first component of transaction cost is the
commission, or fee, charged by the broker for the execution.
These charges are negotiated between parties and vary
from client to client. This analysis assumes execution costs
of $2.50 per contract (0.25bps) for E-mini futures and 2.5
cents per share (1.25bps) for ETFs.2
Market Impact: The second component of transaction
costs is market impact, which measures the adverse price
movement caused by the act of executing the order.
Market impact can be very difficult to quantify. In the
simplest case – an unlimited market order sent directly to
the exchange – the impact can be accurately defined as the
difference between the market price immediately prior to
the order being submitted and the final execution price of
the trade. However, as the execution methodology becomes
more sophisticated and extends over a longer period of
time (e.g. a working order participating at 25 percent of
the volume, or an over-the-day VWAP target) it becomes
increasingly difficult to separate the impact that was caused
by the trade from market movements unrelated to the trade.
The analysis in this report requires an estimate of the
expected market impact from a hypothetical execution, rather
than the actual impact of any specific trade. This anticipated
impact is therefore a statistically-based estimate and may be
very different from that of any particular execution.
In deriving this estimate for the anticipated market impact,
it is important to factor in the transfer of liquidity that
occurs between different products tracking the S&P 500.
1 Price return plus dividends.
2 These rates are indicative of typical “middle-of-the-range” pricing for institutional clients. While commissions and fees are a focus for short-term traders, in the context of the longer-term analysis here, they make only a very small contribution to the total cost.
3 FEBRUARY 2016 | © CME GROUP
When facilitating investor orders in any one of the products
under consideration, liquidity providers will hedge with the
least expensive alternative between futures, ETFs and the
replicating stock portfolio. This creates a “pool” of S&P 500
liquidity in which each product benefits from the liquidity
of the others, which in turn greatly increases the liquidity of
all products.
Based on broker estimates and CME Group’s own analysis,
the market impact of the hypothetical $100 million order is
estimated to be 1.25bps for E-mini futures, 2.0bps for the
SPY ETF, and 2.5bps for both IVV and VOO.
Table 1: Liquidity Comparison
Product AuM / OI ($Bn) ADV ($Mn)
ES 285.0 173,102
SPY 172.9 25,311
IVV 66.1 909
VOO 40.2 382
Fullyear2015ADV.AuM/OIasof1February,2016.Source:CMEGroupandBloomberg.
As a “sanity check” on these values, it is observed that
$100 million represents 0.06% of the average daily notional
value traded in the ES future of approximately $173 billion
(2015 average). As such, a 1.25bps impact estimate –
equivalent to one tick increment – appears reasonable.
Given that the liquidity of the ES future is nearly 7x that
of the SPY and more than 130x that of the IVV and VOO
combined, the impact estimates for these products initially
appear quite low. However, if one factors in the liquidity
pool effect in the S&P 500 and the frictional costs of
converting between the various products, the incremental
cost of 0.75bps for SPY and 1.25bps for IVV and VOO –
corresponding to approximately 1.5cps and 2.5cps,
respectively – appear reasonable.
Holding Costs
Holdingcostsareexpensesthataccrueoverthetimethe
positionisheld.Thesegenerallygrowlinearlywithtime
(e.g.ETFmanagementfees,whichaccruedaily)although
therearesome,whicharediscretebutrecurring(e.g.
executionfeesonquarterlyfuturesrolls).
ThesourcesofholdingcostsforETFsandfuturesare
different,owingtotheverydifferentstructuresofthe
twoproducts.
ETFs: TheholdingcostofanETFisthemanagementfee
chargedbythefundfortheserviceofreplicatingtheindex
return(generallythroughthepurchaseandmaintenance
oftheunderlyingstockportfolio).Themanagementfee
forthethreeETFsinouranalysisrangesbetween5.0and
9.45bpsperannum.
Asecondpotentialsourceofholdingcostistrackingerror
betweenthefund’sreturnsandthoseoftheindex(other
thanthoseduetotheapplicationofthemanagementfee).
Thisriskwillbeignoredintheanalysisthatfollows,asit
hasneverbeenanissuewiththeETFsunderconsideration
andassuch,thereisverylimitedbasisforestimatingthe
magnitudeorimpactofpotentialdeviations.
Futures:Futurescontractsarederivativesandprovide
leverage.UnlikeanETF,wherethefullnotionalamount
ispaidbythebuyertothesellerattradeinitiation,with
futurescontracts,nomoneychangeshandsbetweenthe
parties.Rather,bothbuyerandsellerdepositmarginof
approximately5.2percent3ofthenotionalofthetrade
withtheclearinghousetoguaranteetheirobligations
underthecontract.
3 At time of writing the margin requirement on E-mini S&P futures is $4,700 on a contract notional of roughly $91,300. Margin amounts are subject to change.
4 FEBRUARY 2016 | © CME GROUP
AscomparedwiththeETFmanagementfee,buyersof
futurescontractsareimplicitlypayingthesellersnotonly
toreplicatetheindexreturns,butalsotodosowiththeir
ownmoney.Asaresult,thepriceofafuturescontract
containsacomponentthatrepresentstheinterest
chargesonthese“borrowed”funds4.
Giventhetradingpriceofthefutures,onecaninfertherate
thatthemarketisimplicitlychargingonthese“borrowed”
funds.Whilethisfundingcostisimpliedinallfutures
transactions,itismostreadilyinferredfromtradinginthe
futuresrollandfrequentlyreferredtoasthe“rollcost.”
Comparingthisimpliedinterestratewiththecorresponding
USD-Liborrateoverthesameperiod,onecancalculatethe
spreadtoLiboranddeterminewhetherthefutureisrolling
“rich”(impliedfundingaboveLibor,positivespread)or
“cheap”(impliedfinancingbelowLibor,negativespread).
Forafully-fundedinvestor(i.e.onethathascashequal
tothefullnotionalvalueoftheposition),therichnessor
cheapnessoftherollisnotmerelya“theoretical”costbut
theactualholdingcostforindexreplicationviafutures.The
investorrealizesthiscostbybuyingthefuturescontracts
andholdinghisunusedcashinaninterest-bearingdeposit.
Throughthefuturescontracts,hepaystheimplied
financingrateonthefullnotionalofthetrade,whileonthe
unusedcashondeposithereceivesarateofinterest,which
isassumedtobeequalto3-monthUSD-Libor(3mL)5.The
differencebetweentheinterestpaidandinterestearnedis
theholdingcostofthepositionandisequaltotherichness
orcheapnessoftheroll.
Observations on the Futures Roll
Unlikeamanagementfee,theimpliedfinancingcostof
thequarterlyfuturesrollisnotconstantbutdetermined
bytheforcesofsupplyanddemandandarbitrage
opportunitiesinthemarket.
Historically,theimpliedspreadtoLiborofESfutureswas
belowthelowestmanagementfeesonanyETF.Overthe
ten-yearperiodbetween2002and2012,theESfuturesroll
averaged2bpsbelowfairvalue6.
Since2012,thepricingoftherollhasbecomemorevolatile
andtradedatvariedlevelsasshowninFigure1,withthe
richnessaveraging35bpsin2013,26bpsin2014and8bps
in2015.
Thisrecentrichnessisattributabletotwomainfactors:
changesinthemixbetweennaturalsellersandliquidity
providersonthesupply-sideofthemarket,andchanges
tothecostsincurredbyliquidityproviders(particularly
banks)infacilitatingthisservice.
Inabalancedmarket,naturalbuyersandsellerstradeata
priceclosetofairvalue–neitherpartybeinginaposition
toextractapremiumfromtheother.Whennonatural
sellerisavailable,aliquidityproviderstepsintoprovide
supply(i.e.sellfutures)ataprice.Thegreaterthedemand
onliquidityproviders,thehigher(andmorevariable)
theimpliedfundingcostswillbe.Conversely,ifmarket
conditionsattractmorenaturalsellers,thisdemandon
liquidityproviderscanbediminishedviatheredistribution
amongstmarketparticipants,whichwillbothstabilizeand
lowertheimpliedfundingcosts.
4 The argument is symmetric for the seller. The short sale of an ETF would generate cash, which would earn a rate of interest. The sale of a futures contract generates no cash, and so the implied interest in the futures price compensates the seller for this.
5 As with other assumptions in the analysis, this value represents a “middle-of-the-range” yield on uninvested cash.
6 Goldman Sachs, “Futures-Plus”, 22 January, 2015.
5 FEBRUARY 2016 | © CME GROUP
Figure 1: S&P 500 Futures Roll Richness with High/Low Range7
Mar
-11
Jun-
11
Sep-
11
Dec
-11
Mar
-12
Jun-
12
Sep-
12
Dec
-12
Mar
-13
Jun-
13
Sep-
13
Dec
-13
Mar
-14
Jun-
14
Sep-
14
Dec
-14
Mar
-15
Jun-
15
Sep-
15
Dec
-15
Fina
ncin
g Sp
read
vs.
3m
L
(40)
(20)
0
20
40
60
80
Average Weighted Roll (3 Weeks Prior to Expiration)
High Low Average Daily Roll Rate Range
ThepersistentlystrongS&P500returnsfrom2012to
2014(averageannualgrowthof20.2percent)causeda
decreaseinthesizeofthenaturalshortbase,as
institutionalinvestorsreducedshortsandbiasedtheir
positionstowardlongexposure.Thisincreaseddemandon
theremainingshort-sideliquidityproviders–e.g.
leveragedshorts,hedgefundsandU.S.banks–occurred
atatimewhenaccesstobalancesheetandfundingwere
increasing,allofwhichplacedupwardpressureonthe
impliedfinancingoffutures,asdisplayedinFigure1.
The-0.73percentstagnantreturnoftheS&P500
in2015coupledwiththeresurgenceofvolatilityin
equitymarketsinthelatterpartof2015andearly2016
increasedthenaturalshortbaseinthemarketand
exerteddownwardpressureonfutures’impliedfinancing
levels.Thissequenceofeventsandcheapeningoftheroll
demonstratethattherollmarketiscontrolledbyseveral
complexfactorsandthattheaforementionedfactors
thatappliedupwardpressureonimpliedfinancing
costsdidnotrepresentpermanentshiftsinthemarket,
norwasonefactordominantindrivingtheembedded
richness.Meaning,iftheprimarydriveroftheroll
richeningwasbelievedtobetheregulatoryandcapital
pressuresononesegmentofliquidityproviders–U.S.
banks,forexample–therollrichnesswouldnothave
abatedby50bpsfromDecember2014toDecember2015
whiletherewasnoconcurrentshiftin,orrelaxationof,
theregulatoryorcapitalregimeintheU.S.
In2014,therollmarketbegantorenormalizewiththe
March,JuneandSeptemberrollsaveragingjust17bps
(lessthanhalftheDecember2012toDecember2013
level)andtradingaslowas7bpsinSeptember8.The
subsequentrichnessoftheDecember2014rollindicates
thatsomeyear-endeffectsremained.Throughout2015,
asaresultofmarketconditions,arebalancingofmarket
long-shortbiasandnewparticipantsextractingpremium
viatheabove-marketfinancingrates,therollmarket
cheapenedto2012levels,withboththeSeptemberand
December2015rollperiodstradingatsub-Liborlevels.
Intheanalysisthatfollows,E-miniS&P500futuresare
evaluatedagainstthecorrespondingETFsintwoscenarios
wherethefuturesareassumedtorollatthe2014-2015
two-yearaverageof20bpsabove3mL,andattheH2-2015
sub-Liboraverageof5.7bpsbelow3-monthUSD-Libor.
Table2summarizesthecostestimatesusedinthe
analysis.Theexecutionfeesofthequarterlyfuturesroll
areassumedtobethesameasinthetransactioncost,
appliedtwiceateachroll.
Table 2: Summary of Assumptions (in bps)
Product Execution Fees
Market Impact
Holding Cost (per annum)
ES 0.25 1.25 20.0/-5.7
SPY 1.25 2.00 9.45
IVV 1.25 2.50 7.0
VOO 1.25 2.50 5.0
7 The blue line shows the weighted average richness of the roll over the three weeks leading up to expiry, and the grey bars indicate the highest and lowest average daily rate over the period.
8 Source: CME Group Equity Quarterly Roll Analyzer tool
6 FEBRUARY 2016 | © CME GROUP
SCENARIO ANALYSIS
Havingestablishedbaselinetransactionandholdingcost
estimates,itisnowpossibletocomputethetotalcost
ofindexreplicationviafuturesandETFsforvarioususe
cases.Thisreportwillconsiderfourscenarios:afully-
fundedinvestor,aleveragedinvestor,ashortsellerandan
internationalinvestor(i.e.non-U.S.domicile).Ineachcase,
totalcostiscomputedforallholdingperiodsupto
12months.
Allscenariosassumethesametransactioncostsand
recognizetheround-tripfeesandmarketimpactat
tradeinitiation.Futuresrollcostsareassessedonthe
Wednesdaybeforeeachquarterlyexpiry.
Whileitisnotspecificallymentionedintheexplanations
ofeachscenario,allfuturescarrycalculationshavebeen
adjustedforthemargindepositedwiththeCMEclearing
house,anditisassumedtonotearninterest.Atcurrent
interestratestheimpactisapproximately1.3bpsperannum.
Scenario 1: Fully-funded Investor
Forthefully-fundedinvestor,thetotalcostofindex
replicationoveragivenperiodisthesumofthetransaction
costsplusthepro-rataportionoftheannualholdingcosts.
Figure2showsthecostofindexreplicationviaindex
futuresandETFsfortimehorizonsouttosixmonths,
assumingaJanuarythroughJuneholdingperiodandthe
transactionandholdingcostestimatesinTable2.
Figure 2: Fully-funded Investor, 6 months
-
Tota
l Cos
t (bp
s)
Holding Period
2
4
6
8
10
12
14
16
VOOIVVSPYES Futures (-0.06%)ES Futures (+0.20%)
Thestartingpointforeachgraph(theintersectionwiththe
verticalaxis)representstheround-tripexecutioncost,
rangingfrom2.9bpsforfuturestobetween6.5and7.5bps
forETFs.Mostofthelinesslopeupwardastimepasses,
reflectingthegradualaccrualoftheannualholdingcosts,
withsmalljumpsinthefutureslineduetothecostof
quarterlyfuturesrolls.Becausetheannualmanagement
feesontheETFsarebelowanimpliedrichnessof+20bps
onfutures,thegraphsoftheETFsslopeupwardmore
slowlythanthatofthefutures.Theoppositeholdstrue
whenfuturescarryanimpliedcheapnessandthe
downwardslopeofthelinerepresentsthepremiumthat
canbeextractedviarollingfuturescheaptoLibor.Atan
impliedcheapnessof-5.7bps,theETFmanagementfees
areabovetheholdingcostofthefuture,andthisdivergent
relationshipexistsfortheentireperiod.
7 FEBRUARY 2016 | © CME GROUP
Forshortholdingperiods,thehighertransactioncostsof
theETFsmakethefuturesmoreeconomicallyattractive
regardlessoftherollrichnessorcheapness(futuresline
belowallthreeETFlines).Thismakesfuturesaparticularly
attractivetoolformoreactive,tacticalandshort-term
traders.Forlonger-termholders,thecumulativeeffectsof
impliedfinancingmaketheETFamoreefficientalternative
whenfuturesarerollingrich,andlessefficientwhenfutures
arerollingcheap.
At3mL+20bps,thebreakevenpointatwhichETFsbecome
amoreeconomicallyefficientalternativeoccursinthe
fourthmonth.Inthisspecificexample,theVOObreakeven
arrivesfirstonday91,followedbytheSPYonday94and
theIVVonday104.However,at3mL-5.7bps,theETFsnever
reachabreakevenpointandfuturesremainthemorecost-
effectivealternativeinperpetuity.Tobeclear,itisnotjust
theswitchfromrichtocheapthatmakesfuturesmorecost
effective,overtimeitistherelationshipbetweenthefutures
embeddedspreadtoLiborandtheETFmanagementfee.
Infact,iftheimpliedfinancingoftherolltradesrichat,or
lowerthan3mL+2.9bps,futureswillremainbetterthan
theETFoverafour-yearholdingperiod,astheembedded
richnessislessthanthedragonperformancegeneratedby
themanagementfeeassociatedwithholdingtheETFs.
InFigure3,wheretheanalysisisextendedouttoa
12-monthholdingperiod,whenfuturesrollat3mL+20bps,
onecanseethatETFsarecheaperthanfuturesbybetween
10.3and13.7bps,andatthe3mL-5.7bpsrolllevelfutures
arecheaperthantheETFsbybetween12.0and15.5bps.
Figure 3: Fully-funded Investor, 12 months
-
Tota
l Cos
t (bp
s)
Holding Period
2
4
6
8
10
12
14
16
18
20
22
24
26
28
ES Futures (+0.20%) ES Futures (-0.06%) SPY IVV VOO
Scenario 2: Leveraged Investor
Equityindexfuturesareleveragedinstruments.The
investorpostsapproximately5percentmargintothe
exchange,whichresultsinover20xleverageontheir
position.ThethreeETFsinthisanalysisarenotleveraged9
butmaybepurchasedonmarginbyinvestorswhodesire
leverage.
Thedifferenceisthequantityofleveragethatispossible.
UnderFederalReserveBoardRegulationsTandU,there
arelimitsontheamountabrokermaylendtoaninvestor
wishingtopurchasesecuritiesonmargin.
UnderRegT,themaximumamountthatcanbelentis50
percentofthepurchaseprice,resultinginamaximumof
2xleverage.Moresophisticatedinvestorsmaybeeligible
forportfoliomarginingthroughaprimebrokerunder
whichtheycouldpotentiallyachieve6-8xleverageunder
RegU.Greaterthan8xleverageisnotpossible.
ToderiveaholdingcostfortheETFpositionpurchased
withleverage,standardprimebrokerlendingratesforan
institutionalclientof3mL+40bpsareassumed.
9 Leveraged ETFs are excluded from this analysis, as these have path-dependent returns which are very different from standard ETFs or futures.
8 FEBRUARY 2016 | © CME GROUP
Two-times Leveraged Investor
Thestartingpointfortheanalysisisthe2xleveragedcase.
Thisimpliesthattheinvestorhas$50millionwithwhich
totakeon$100millionofexposure.
TheETFinvestor,whomustpaythefullnotionalamount
ofthetradeatinitiation,borrows$50millionfroma
primebrokertofundthepurchase.Theholdingcostof
theleveragedpositionisthereforethesameasthefully-
fundedposition(Scenario1)plustheinterestcarryonthe
borrowed$50millionat3mL+40bps.
Withfutures,itisnotaquestionofborrowingmoney,as
aninvestorwith$50millionalreadyhasapproximately
10xtherequiredmargindeposit.Rather,itisacaseof
havinglessmoneytodeposittodefraythe3mLbaseline
financingcostembeddedinthefutures.Inthefully-funded
case,itwasassumedthattheinvestor’s$100million
depositearnedinterestat3mL,whichfullyoffsetthe3mL
componentofthefuturesimpliedfinancingrate;leaving
onlythepositive(ornegative)spreadtoLiborasthe
financingcost(orcredit)onholdingtheposition.Inthe2x
leveragedcase,theamountofcashavailabletodepositis
reducedby$50million,andtheinvestor’sdepositcanonly
generateenoughinteresttooffsethalf($50million)ofthe
3mL-basedfinancingonthetotalfuturesnotional($100
million).Asaresult,the2x-leveragedinvestorwillincurthe
embeddedbaseline3mLfinancingcostontheremaining
halfofthefuturesnotional,plustheentireexpenseofthe
positivespread(orlessthecreditofthenegativespread)
to3mLonthefullfuturesnotional($100million),aswas
depictedinthefully-fundedscenario.Viewedthisway,the
holdingcostofthe2xleveragedscenarioforfuturesis
identicaltothefully-fundedscenarioplusthenewinterest
expenseon$50millionat3mL.
Figure 4: Total Cost for 2x and 8x Leverage, 12 months10
-
10
20
30
40
50
60
70
80
90
100
110
Holding Period
Avg. ETFs, 2x Avg. ETFs, 8x ES Futures (+0.20%) 2xES Futures (+0.20%) 8x ES Futures (-0.06%) 2x ES Futures (-0.06%) 8x
Tota
l Cos
t (bp
s)ThedashedlinesinFigure4showthetotalcostofindex
replicationona2xleveredbasisforholdingperiodsupto
12months.
Comparedtothefully-fundedscenarioinFigures2and3,the
totalcosthasincreasedforbothETFandfuturespositions.
However,duetoabove-Liborrateschargedonborrowed
fundsbyaprimebroker,theETFholdingcosthasincreased
by20bpsperannummorethanthefutures(40bpsspread
ononehalfofthetradenotional).Asaresult,futuresarethe
moreeconomicaloptionacrossalltimehorizons.
Eight-times Leveraged Investor
Theanalysisforthe8xleveragedcaseproceedsina
similarfashion.Inthiscase,theinvestorhas$12.5million
ofcashwithwhichtoobtain$100millionofexposure.
TheETFinvestorthereforehasan$87.5millionloanfrom
theprimebroker,whilethefuturesinvestorhasan$87.5
millionreductionintheirdeposit.
10 To simplify the graphical representations, Figures 4-6 show the average of the total costs of the SPY, IVV and VOO. The individual results for each ETF are within ±2bps of the value shown at all time horizons.
9 FEBRUARY 2016 | © CME GROUP
ThesolidlinesinFigure4showthecostcomparisonfor
the8xleveredcase.Astheamountoffundsborrowed
increases,theincrementalborrowingcostofaprime-
brokerfundedETFpositionincreases,ascomparedwith
theincreasedintrinsiccostofleverageembeddedin
thefutures.Inthe8xleveredcase,the40bpsfunding
differentialon87.5percentofthenotionalofthetrade
resultsina35bpsgreaterincreaseintheholdingcostof
ETFsrelativetofutures.
ThecostadvantageoffuturesoverETFsforaone
yearholdingperiodwhenfuturesaretradingrichat
3mL+20bpsis8.2and23.2bpsforthe2xand8x
leveragedcases,respectively;andatH2-2015levelsof
3mL-5.7bps,thecostadvantageoffuturesimproves
to33.9bpsand48.9bpsforthe2xand8xleveraged
investor,respectively.
Thisanalysishasbeenconductedusingcurrent3mLrates
ofapproximately0.60percent.Asinterestratesrise,the
absolutecostofleveragedexposurewillincreaseforboth
products.However,thedifferencebetweentheholdingcosts
ofETFsandfuturesisnotafunctionoftheabsoluteratebut
ofthespreadbetweencashondepositandborrowedcash
andpersistsacrossdifferentinterestrateregimes.
Scenario 3: Short Investor
Ashortpositionprovidesnegativemarketexposureandis
inherentlyleveraged.
WithETFs,theleveragecomesintheformofaloanof
sharestosellshortbyaprimebroker.Thesaleofthe
borrowedsharesraisescash,whichremainsondeposit
withtheprimebroker.Theshortsellerpaysabpsper
annumfeetothelenderoftheETF,whichisdeducted
fromtheinterestpaidonthecashraisedbythesale.
Atypicalprimebrokerborrowfeeof40bpsperannum
isassumed,resultinginareturnoncashraisedof
3mL–40bps11.
Inadditiontothecashraisedfromtheshortsale,the
investormustpostanadditional50percentofthe
notionalofthetradeincashtothebrokerasmargin12.
Theadditionalfundspostedtotheprimebrokerwillbe
assumedtoearn3mL.
Becausetheyareusingderivatives,theshortseller
offuturesdoesnotneedtoborrowsharesorpaythe
associatedfee.Thesaleofafuturescontractisidentical
tothepurchase,withthesamemarginpostedwiththe
clearinghouse.
Whenanalyzingtheeconomicsofashortposition,itis
importanttorememberthattheholdingcostsforthelong
investorbecomebenefitsfortheshort.ETFmanagement
feescauseasystematicunderperformancerelativetothe
benchmarkwhich,fortheshortinvestor,representsan
excessreturn.Therichnessofthefuturesrollprovidesa
similarbenefitforfuturesinvestors.
11 This rate, combined with the assumption on long funding of 3mL + 40bps, results in an 80 bps “through-the-middle” prime broker bid / offer, which is consistent with market standards.
12 Higher leverage may be eligible under portfolio margining, but we will focus on the 2x levered case.
10 FEBRUARY 2016 | © CME GROUP
TheholdingcostsforshortpositionsinfuturesandETFs
canbedecomposedasfollows:
Futures:
1) Receivefutures’impliedfundingrateof3mL+20bps
onthe$100million
2) Receive3mLon$50millioncash
ETFs:
1) Receivethemanagementfeeof5-9.45bps
2) Receive3mL-40bpson$100millionraisedfromthe
shortsale
3) Receive3mLonthe$50milliondepositedwiththe
primebroker.
Figure5showsthatinbothcasestheholdingcostsare
negative–overtime,theinvestor’srelativeperformance
versustheshortreturnofthebenchmarkimproves,as
demonstratedbythedownwardslopeoftheline.
However,duetothecombinationofhigherETFtransaction
costsandthefundingspreadschargedbyprimebrokers,
thefuturesprovideamorecost-effectiveimplementation
acrossalltimehorizons,regardlessiffuturesaretrading
richorcheap.Whileitismathematicallyandtheoretically
possiblethatthecheapnessembeddedinthefutures
couldbesonegativetoLiborthatthePrimeBrokerrebate
ratecouldtradelessnegativeandoutpacethefuturein
theshortscenario,thiswouldneverhappeninrealitygiven
theinterrelatednessoftheS&P500products.Asthe
embeddedfinancingcheapened,thePrimeBrokerwould
havetolowertheirspreadtomorenegativelevelstoearn
aprofitoverandtokeeppacewiththetrueassetvalue
rebateoftheS&P500thatisgenerallybetterreflectedin
thefuture.
Thecostadvantageoffuturesatthe3mL+20bps
rollcostoverETFsfora12-monthholdingperiodis
53.8bps,andevenwhenfuturesfinancingistrading
atthesub-Liborlevelof3mL-5.7bps,futuresarestill
morecosteffectiveby28.1bps.
Figure 5: Short Futures vs. ETF, 12 months
(110)
(100)
(90)
(80)
(70)
(60)
(50)
(40)
(30)
(20)
(10)
0
10
20
Tota
l Cos
t (b
ps)
Holding Period
ES Futures (+0.20%) ES Futures (-0.06%) Avg. ETF
Scenario 4: International
CME Group does not provide tax advice. Investors should consult
their own advisors before making any investment decision.
Ingeneral,foreigninvestorsintheU.S.equitymarketare
subjecttoawithholdingtaxondividendpaymentsbyU.S.
corporations.Thebasewithholdingrateis30percent,
resultingina“net”dividendreceivedbyforeigninvestors
equalto70percentofthe“gross”dividendavailableto
U.S.investors.
Thiswithholdingtaxalsoappliestofunddistributions
paidoutbyETFs.AllthreeoftheETFsinthisanalysis
payaquarterlydistribution,whichrepresentsthepass-
throughofdividendincomereceivedbythefundonthe
underlyingsharesheld.ThedividendyieldoftheS&P500
isapproximately2.15percent,whichimpliesanadditional
64.5bpsholdingcostperannumforforeignETFinvestors
duetothewithholdingtax.
11 FEBRUARY 2016 | © CME GROUP
Futurescontracts,unlikeETFs,donotpaydividends.The
marketpriceofthefuturecontainsanimplieddividend
amount,whichgenerallycorrespondstothefullgross
dividendyieldontheunderlyingindex13.Thereisnofutures
equivalenttothedividendwithholdingtaxonETFshares.
Figure6showsholdingcostcomparisonforafully-funded
longposition(Scenario1)asexperiencedbyanon-U.S.
investorbasedona30percentwithholding.
Inthethree-monthperiodpriortothefirstdividend
ex-datethecomparisonisidenticaltoScenario1:the
lowertransactioncostsoffuturesmakethemacheaper
alternative.Justpriortothecross-overpointwhereETFs
becomemorecosteffective,the16.125bpsimpactofthe
withholdingtaxonthefirstquarterlydividendhitsthe
totalcostoftheETFcausingthejumpinthegreyline.As
aresult,thefutureisamorecosteffectivealternativeover
alltimehorizons.
Absentextremerichnessofthefuturesroll,ofan
approximate3mL+75bps,thecostadvantageof
futuresoverETFsforforeigninvestorswillholdtrue
inperiodsofrollrichnessandcheapnessmainly
becausethisisanadditionalholdingcostthatonlythe
ETFincurs.Overa12-monthholdingperiod,futures
at3mL+20bpswilldemonstrateacostadvantage
of52.6bps,andatthe3mL-5.7bpsfinancinglevel,
futureswillenjoya78.3bpsbenefit.
Figure 6: Foreign Investor (30% WHT), 12 months
(10)
0
10
20
30
40
50
60
70
80
Tota
l Cos
t (b
ps)
Holding Period
ES Futures (+0.20%) ES Futures (-0.06%) ETF, WHT 30%
Certaininternationalinvestorsareabletoreclaimsomeor
allofthedividendordistributionwithholdingtaxonETF
distributions.Apartialreclaimreducesthesizeofthe
“steps”inFigure6,whileatax-exemptforeigninvestor(i.e.
afullreclaim)iseconomicallyequivalenttoaU.S.investor
(Scenario1).
Fordividendrateslessthan95percentofgross(i.e.5
percentwithholding),thosefuturesoutlinedhereinaremore
costeffectiveacrossalltimehorizonsgiventhefuturesrich
scenarioof3mL+20bps.Giventheone-sidednatureof
dividedwithholdingtaxinthisanalysis,itisfairtodiscern
thatthereisavariablerelationshipbetweenthedegree
ofrichnessembeddedinfuturesandtheETFs’required
break-evenwithholdingrate.Iffuturesrichenedbeyond3mL
+20bps,aforeigninvestorcouldbewithheldgreaterthan5
percentonETFdividendpaymentsandstillbreakeven,albeit,
evenatmoderatelevelsofrichnessofthefuturesroll,itstill
requiresaveryhighreclaimratetoabatethewithholding
impactexactedonETFs.
13 The market price of a futures contract is a function of interest rates and anticipated future dividends. Deviations from fair value can be attributed to either component based on the investor’s assumptions. For example, the futures roll trading above fair value can be viewed as the result of above-market implied funding rates, a lower dividend assumption or a dividend withholding tax. The market standard is to attribute deviations to implied funding costs unless there is a known ambiguity around the timing or quantity of a particular dividend.
12 FEBRUARY 2016 | © CME GROUP
UnlikeETFmanagementfees,whicharebeneficialtoshort
investors,thewithholdingcostonfunddistributionsdoes
notresultinoutperformanceforforeigninvestorslooking
totakeonshortexposure.Thestandardinthestockloan
marketisthattheborrowerofthesecuritypaysthefull
grossdividend.
Other considerations
Thisanalysishas,thusfar,focusedoncost.Thereare,
however,anumberofotherfactorsthatimpactinvestors’
productselectiondecisions.Forcompleteness,themore
salientconsiderationsareenumeratedhere.
Tax: E-miniS&P500futuresaresection1256contracts
withablendedU.S.capitalgainstreatmentof60percent
longtermand40percentshortterm,regardlessofholding
period,whichmayimprovetheafter-taxefficiencyof
futuresversusotheralternatives.
UCITS:Equityindexfuturesareeligibleinvestmentsfor
EuropeanUCITSfunds,whileU.S.-listedETFsarenot.
Currency: Theleverageinherentinafuturescontract
allowsnon-USDinvestorgreaterflexibilityinthe
managementoftheircurrencyexposuresascomparedto
fully-fundedproductslikeETFs.
Short Sale: Manyfundshavelimitations,eitherby
mandateorregulation,whichlimittheabilitytosellshort
securities.Thesefundsmay,however,beabletotakeon
shortexposureviaderivativessuchasfutures.(UCITS
fundshavesuchrestrictions.)Futuresarealsonotsubject
tolocaterequirements,RegulationSHOorRule201.
Fixed Versus Variable Dividends: Afuturescontractlocks
inafixeddividendamountatthetimeoftrade,while
ETFsaccruetheactualdividendstothefund’sNAVasand
whentheyoccur.
Product Structure: ETFsaremutualfunds,whilefuturesare
derivatives.Fundinvestmentmandatesandlocalregulations
maytreatthesestructuresdifferentlyandimposediffering
degreesofflexibilityintheirusagebythefundmanager.
Theassetmanagementcompany(ortheparticularfund
manager)mayalsohavepreferences.Somefundsmaylook
tolimittheiruseofderivativesandthereforeprefertheETF.
Alternately,managersmayprefernottouseaproductthat
paysamanagementfeetoanotherassetmanagerorhave
concernsaboutinvestors’perceptionsoftheiruseofother
issuers’fundsintheportfolio.
13 FEBRUARY 2016 | © CME GROUP
CONCLUSION
Figure7summarizestheresultsoftheanalysis.Atthe
two-yearrollfinancingaverage(2013-2015)of3mL
+20bps,forallscenariosbutone,futuresprovidea
morecost-effectivevehicleforreplicatingS&P500
indexreturns.However,asdisplayedbytheH2-2015roll
financingaverage,atthesub-Liborlevelof3mL-5.7bps
futuresarethemostcost-effectiveproductchoicefor
replicatingS&P500indexreturns.Where,solongas
aninvestors’holdingperiodisfouryearsorfewer,and
futuresrollatorbelowacostof3mL+2.9bps,futureswill
alwaysbethebesttoolforaccessingtheS&P500forall
investors–eventhelong-termbuy-and-hold,
fully-fundedinvestor.
Figure 7: Summary of Results
Scenario
Cheapest Option
Roll is Cheap (Below 3-month USD Libor)
Roll is Rich (Above 3-month USD Libor)
Fully-Funded FuturesDepends on holding period and degree of richness
Leveraged(2x,8x)
Futures Futures
ShortSeller Futures Futures
International Futures Futures
Scenario: Fully-Funded, Roll Cost at a Premium to 3-month USD-Libor
Spread to 3-month USD-Libor
E-mini S&P 500 futures are more cost effective than ETFs for all investors when the Roll Cost trades at, or below, the following holding periods:
30 Days
60 Days
90 Days
180 Days
1 Year
2 Year
4 Year
+51 bps
+30 bps
+20 bps
+11 bps
+6.3 bps
+4.0 bps
+2.9 bps
Investorsareremindedthattheresultsinthisanalysisare
basedonthestatedassumptionsandgenerallyaccepted
pricingmethodologies.Theactualcostsincurredbyan
investorwilldependonthespecificcircumstancesofboth
theinvestorandtheparticulartradeincludingthetrade
size,timehorizon,brokerfees,executionmethodologyand
generalmarketconditionsatthetimeofthetrade,among
other.Investorsshouldalwaysperformtheirownanalysis.
FormoreinformationonCMEGroup’ssuiteofequityindex
futuresandoptionsonfutures,pleasecontactyourCME
Groupaccountmanagerorsalesrepresentative.
ForquestionsorcommentsaboutthisreportorCME
EquityIndexproducts,[email protected].
PM1304/00/0216
DistributedwithpermissionfromCMEGroup.
CMEGroup®isaregisteredtrademarkofChicagoMercantileExchangeInc.TheGlobelogo,CME,ChicagoMercantileExchange,Globex,CMEDirectandCMEDirectMessengeraretrademarksofChicagoMercantileExchangeInc.ChicagoBoardofTradeisatrademarkoftheBoardofTradeoftheCityofChicago,Inc.NYMEXisatrademarkoftheNewYorkMercantileExchange,Inc.Standard&Poor’sandS&P500®aretrademarksofTheMcGraw-HillCompanies,Inc.andhavebeenlicensedforusebyChicagoMercantileExchangeInc.
Futurestradingisnotsuitableforallinvestors,andinvolvestheriskofloss.Futuresarealeveragedinvestment,andbecauseonlyapercentageofacontract’svalueisrequiredtotrade,itispossibletolosemorethantheamountofmoneydepositedforafuturesposition.Therefore,tradersshouldonlyusefundsthattheycanaffordtolosewithoutaffectingtheirlifestyles.Andonlyaportionofthosefundsshouldbedevotedtoanyonetradebecausetheycannotexpecttoprofitoneverytrade.Allexamplesinthisbrochurearehypotheticalsituations,usedforexplanationpurposesonly,andshouldnotbeconsideredinvestmentadviceortheresultsofactualmarketexperience.
TheinformationwithinthisbrochurehasbeencompiledbyCMEGroupforgeneralpurposesonlyandhasnottakenintoaccountthespecificsituationsofanyrecipientsofthisbrochure.CMEGroupassumesnoresponsibilityforanyerrorsoromissions.AllmatterspertainingtorulesandspecificationshereinaremadesubjecttoandaresupersededbyofficialCME,NYMEXandCBOTrules.CurrentCME/CBOT/NYMEXrulesshouldbeconsultedinallcasesbeforetakinganyaction.
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