ETFs and Tokenised Funds: New Building Blocks of Treasury Investment?

In the December 2021 Calastone Connect Forum, experts considered how exchange traded funds and tokenised funds could, and potentially should, become part of every treasurer’s asset class armoury for managing liquidity. Ed Lopez, Chief Revenue Officer, Calastone; Patrick Kunz, Treasury, Finance & Risk Consultant and Interim Treasurer, Pecunia Treasury & Finance; and Natacha Blackman, Fixed Income Product Strategist for iShares ETFs, BlackRock, pondered the possibilities.

Tokenised funds

There has been much talk of tokenised funds in recent months but there appears to be some confusion as to what they are and the panel was keen to put the record straight. Indeed, it was noted that talk of tokenised funds typically turns to blockchain and assumptions that they equate to crypto and Bitcoin, noted Lopez. “But that’s not what tokenised funds are,” he stated. Tokenised funds, he explained, do use DLT to secure sensitive fund data, but while DLT is fundamental to both tokenisation and crypto, it is important to see the difference.

Tokenisation requires tools) to create and distribute tokens, offering new advantages from a fund manager and asset manager perspective by removing much of the operational burden, and therefore cost, clarified Lopez. “By replacing legacy processes, asset managers can concentrate on their core business, offering value and choice to investors.”

In fact, tokenisation of underlying assets enables tokens to be creatively mixed, in the same way that ETFs (exchange trade funds – see below) can be. This facilitates investment optionality. By enabling bespoke investments, individual investors can focus on what matters to them, many, for example, now tailoring investments to meet their ESG goals.

The flexibility offered by tokenisation appeals to Kunz, with his ‘consultant’ hat on. “I love the concept; it’s the future, making it easier to invest, and easier to combine different asset classes in one token,” he enthused. However, in his ‘treasurer’ guise, he acknowledged that many questions still need to be answered to gain corporate approval, not least around blockchain ownership, counterparty definition, cyber-security, and investment risk.

For Lopez, a trusted technological base is key to the delivery of tokenisation. Calastone is already operating in 52 markets around the world but today it is partnering with Microsoft Azure for optimal delivery. “We are focused on security, privacy, and scalability.” Lopez notes that this is a shared vision with Microsoft that sees both organisations complement each other via a leading footprint in the financial services industry and relevant technology that combine cloud and distributed ledger to meet investor needs head on. No doubt the combination of Calastone and Microsoft Azure using both cloud and DLT to transform funds will enable treasurers to comfortably seek approval from their CFOs and compliance teams.

Timeline

Uptake of tokenised funds is being driven by the retail sector, noted Lopez. Convinced there is “a little bit of a race out there”, he commented that retail providers will likely be busy answering key investor concerns in the next 12 to 18 months. “The corporate and institutional players are only slightly behind.”

In conversation in summer 2021 with a number of US-based institutional MMF providers about delivery of the first institutional money market tokenised fund, he reported all quoting a two-year timeline, some even suggesting 2022.

Lopez admitted that core treasury systems are not necessarily formatted to trade, book and account for tokens, but he commented too that many corporate treasurers require only small technological changes to leverage this new asset. In deploying the right solution – Calastone is on hand to help – additional process benefits will arise from “stripping out some of the technology burdens that exist today”. It is, he concluded, a proposition very much worth considering from multiple angles.

ETFs

For those who haven’t had much experience in this area, it was explained that exchange traded funds (ETFs) are pooled funds that track an index which, like stocks, can be traded on an exchange. This gives them a secondary market, which in turn means they can trade intraday – unlike mutual funds, which price only once per day.

Blackman stepped up to explain that they are a liquid instrument used to gain cost-efficient access to fixed income markets, as an alternative to trading individual bonds. She added that the purpose of an ETF is to offer a well-diversified index-like return, although yield depends on market focus. Indeed, as “a viable way of diversifying a portfolio”, Lopez continued that the yield pickup and intraday liquidity of ETFs can be a good complement to existing day-to-day liquidity strategies.

Uptake uptick

The adoption of fixed income ETFs continues to progress, driven primarily by institutional investors. Low yields and heightened fee pressure have fostered change in investor portfolio construction, noted Blackman. It’s a steady evolution that has been amplified by deepening ETF liquidity and some broader enhancements seen in the fixed income trading ecosystem, especially through increasing use of electronic trading.

Encouraging a more diversified pool of investors to this space further enhances liquidity, which in turn promotes greater uptake, as some investors, including treasurers, gradually look beyond their conventional portfolios.

Kunz said he believes there is treasury interest in ETFs, but current low levels of investment are symptomatic of how cash has historically been viewed by companies as “just the end result of doing business”.

Only when the credit crunch hit did companies begin to realise that cash sitting in the bank was not as safe as they had imagined, he commented. Treasurers knew they had to diversify cash across different banks, but then slowly, as returns dropped towards negative, these holdings began to hurt.

“Cash is still king, but I believe treasurers sitting on a pile of cash should not just be looking at their banks for diversification of their exposures,” suggested Kunz. The investment challenge, he acknowledged, is in balancing liquidity, security and yield, especially when catastrophic events such as the pandemic can turn markets suddenly.

Blackman suggested a ‘step-out strategy’ has a role to play here. While ETFs could be useful in supporting treasury’s search for yield, they are unlikely to be used within daily operating or even reserve cash buckets, she comments. Instead, “we see ETFs being held in a strategic bucket, where there’s an investment horizon of one year or more”.

Of course, ETF liquidity needs to be balanced with risk appetite. Generally, explained Blackman, ETFs offer lower-cost diversified exposure. They provide greater transparency, with reporting on daily holdings and price movements, and do not have to be rolled over. ETFs also offer extensive optionality, spanning almost any market segment or currency.

ETF ground rules

Despite the potential benefits, many treasurers currently believe that ETFs are a step too far out of their comfort zone, and Kunz acknowledged that they may not be appropriate for all. “You need to be cash rich; if you’re cash short, it’s not an option for your intraday liquidity or for overnight deposits,” he advised. “But for those who are using cash segmentation, you’ve already taken the first step. The next is determining your risk appetite. Then you can begin exploring which ETFs are suitable for you.”

Lopez was keen to dispel “a number of myths and misconceptions” that may dissuade some from uptake. ETF liquidity has sometimes been cited as a concern. While T+2 settlement is normal, as long as these funds are not intended for day-to-day or intraday cash, but rather for the medium or longer term, he states their liquidity is entirely feasible.

ETF price volatility is occasionally cited too, especially by those who feel it moves them too far from secure liquidity and yield, noted Lopez. “It’s really a matter of taking time to understand ETFs and that current circumstances have accelerated the need for investors to consider new options as part of their longer-term investment approach.”

It’s also important to stress that the ETF product set is expanding. Said Lopez: “there are now bespoke options aligning more with corporate treasury strategies”. These could entice new investors to include ETFs in their overall investment strategy by providing “more comfort and scope for thinking outside the box”.

One much-in-demand theme for all investment types is ESG. “We’re seeing a lot of innovation, and we’re creating new products that are sustainable versions of existing products,” said Blackman.

Running with ETFs

In practical terms, bringing ETFs into a treasury investment policy starts by defining objectives, said Kunz. “If the business has €100m in excess cash sitting in Bank X with no current plans for it, explain to the CFO that treasury wants to diversify into ETFs, either to earn an incremental return or to reduce risk,” he suggested.

“I have clients who see cash in a 60 basis points-negative bank account as a waste of money, so even if treasury can only get 50 basis points-negative on an ETF, it’s money won. Other clients are uncomfortable having €50m at Bank X and would rather have it in an ETF than risk exposure to another bank.”

For treasurers engaging with ETFs, processing is now relatively easy, said Lopez. “Traditional core treasury solutions maybe didn’t have the capability to trade these types of instruments, or required manual intervention. Calastone can help connect existing technologies, removing friction to process as efficiently as any traditional treasury investment.”