Intelligent ETF trading – six ways Nutmeg beats competitors

Rumi Mahmood


5 min read

We’re often asked, why not do it yourself when it comes to exchange-traded funds (ETFs)? Why do you need a discretionary investment manager such as Nutmeg when you could build your own ETF portfolio, if you wanted to? Well, although the transparency, flexibility and cost-efficiency of ETFs are available to almost anyone, we believe that to maximise their power you need to be smart about fund selection and trading. Here are six ways our approach to ETFs benefits our clients.

Economies of scale help us keep your costs low

We net trades through proprietary in-house technology. This means that if a client is withdrawing money, and therefore selling ETF holdings, we match that off with clients who are depositing money, and buying ETFs. Effectively this means we lower the amount that we buy and sell in the market, reducing transaction costs.

In 2019, this approach eliminated almost 37% of trades being transacted in the market, which amounted to trades worth approximately £800 million.

We trade ‘over the counter’ to get you a better deal

We trade the batches of client transactions with market makers. These are intermediary firms that specialise in trading ETFs or dedicated dealing desks at major investment banks. This method of interacting directly with specialised counterparties is known as over-the-counter (OTC) trading. In the vast majority of cases, OTC trading allows us to access deeper liquidity and achieve better prices than if we dealt through the London Stock Exchange.

To explain the point about liquidity: Nutmeg currently invests in 60 ETFs across all our portfolios. In 2019, the overall trading volume of these ETFs – not just our trades but everyone’s – came to about £145 billion. Last year, 64% of that trading volume occurred via OTC trading and only 32% occurred on exchanges1.

In other words, if you were to trade only on the exchange, as most investment platforms offer, you would have access to roughly a third of the liquidity and typically at a higher cost.

When trading an ETF, we select a set range of market-makers that are the most competitive in that fund or asset class, choosing them from the roughly 27 counterparties we trade with. Some counterparties are competitive in fixed income, some in stocks, while others in commodities such as gold. Our approach means the best firms bid against each other to provide the most competitive prices for our clients.

We achieve a much lower spread than the London Stock Exchange

Our intelligent trading approach helps us to minimise the difference between the buy and sell price we are offered on ETFs, what is known as the spread. The lower the spread, the more money we save on transaction costs.

In the chart below, we’ve compared the London Stock Exchange (LSE) annual average spread against Nutmeg’s average spread for several ETFs2. As you can see, we achieved savings as high as 97% last year on the ETFs listed here.

Take for example our favoured US large cap equity fund, which is an iShares ETF known by the stock ticker CSP1. Last year, the average spread for this ETF on the LSE was 0.04%, whereas Nutmeg on average transacted at 0.02%.

The difference is more pronounced in an asset class such as high yield bonds, where typically investors face higher transaction costs. Our favoured high yield bond fund is from Pimco and known by the ticker STHS. Last year, the average spread for this ETF on the LSE was 0.23%. We transacted at just 0.01%.

 

Source: London Stock Exchange and Nutmeg average spreads, 20192

Our spreads beat the exchange even in volatile periods

Our approach has recently been tested in a very volatile market environment. March 2020 brought the fastest bear market in US history. Even in this difficult period, we were able to achieve significantly better spreads than the London Stock Exchange, as shown by the chart below, which examines the period from January to March.

Over this period, the spread for our favoured US large cap equity ETF was 0.16% on the London Stock Exchange. We achieved a spread of 0.004%.

In emerging market equities, which experienced a strong sell-off earlier in the year, Nutmeg transacted at 0.018% in our favoured ETF for this asset class, which is an iShares fund that uses the stock ticker EMIM. The comparable spread on the LSE was 0.12%. In US high yield bonds, which underwent a shock following a collapse in oil prices, Nutmeg achieved an average spread of 0.55%. The comparable LSE average spread was 0.78%.

 

Source: London Stock Exchange and Nutmeg average spreads, January-March 20202

Our efficiencies accumulate, further lowering your transaction fees

If we dig deeper into the buy and sell execution prices we achieved compared with the market quoted price at the exact time of the trade, more trading efficiency is revealed. By crossing trades and trading over-the-counter, the prices we achieved last year were around eight basis points better than what is available to the typical private investor (a basis point is a hundredth of a percentage point, so eight basis points is equivalent to 0.08%)3.

These kinds of amounts may sound minuscule, but over time they accumulate. In the past two years, Nutmeg has saved over £4.5 million this way4. We don’t keep that money. It goes back into our customers’ pockets.

Our experts study the market to ensure we are always well positioned

Human oversight is an integral part of Nutmeg’s investment process. Alongside an investment team, who make asset allocation decisions for our fully managed and socially responsible portfolios, we have an in-house trading team specialising in ETFs.

We remain in continuous communication with major market makers and investment banks so that we are up-to-speed on live market developments, trading strategy and factors that drive pricing developments such as correlations and hedging costs. Alongside this, we monitor premiums, discounts, liquidity, market nuances and other minutiae.

A DIY investor cannot be expected to achieve this kind of engagement with the market. It’s a full-time job.

In conclusion, we worry about every tiny cost so you don’t have to

Investing can be expensive. Often the cost simply to execute an order to buy or sell can be substantial. Smart trading, rigorous ETF research, and fund selection are fundamental components of our asset allocation process at Nutmeg.

Thanks to these measures, and thanks to our scale, technology and specialised trading, we are able to deliver superior cost performance when it comes to trading. These savings accumulate over time. The more you save on costs, the more of your returns you keep – and that can make a big difference over the long term.

Sources

  1. Based on data from Nutmeg and Bloomberg, 2020. The remaining roughly 4% of trading volume is classed as “other”.
  2. Calculations based on the London Stock Exchange time-weighted average monthly spread – the average spread calculated hourly, weighted by the length of time a spread applies. Monthly figures averaged to annual figure. The Nutmeg average spread is an asset weighted average – the spread of each ETF trade calculated relative to the market mid-price at the time of trade, and weighted relative to the total value of trades in the corresponding calendar year.
  3. Based on all trades conducted in 2019, the difference between the market quoted price at the exact time of the trade and the price we obtained.
  4. Based on all trades conducted in 2018 and 2019, the difference between the market quoted price at the exact time of the trade and the price we obtained.

Risk warning

As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past performance is not a reliable indicator of future performance.

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Rumi Mahmood

Rumi Mahmood is an investment analyst here at Nutmeg. He has two years’ industry experience and joined in early 2017 from the Bank of New York Mellon, where he was an analyst in Global Securities Operations. Rumi holds a masters degree in Engineering from the University of Manchester.


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