Bank of America Offers Mutual Funds Algorithm for Exchange Traded Funds

Bank of America Corp., the largest U.S. lender by assets, is offering clients an electronic trading strategy that can automatically create shares of exchange-traded funds by buying and selling stocks and hedging with futures.

The Charlotte, North Carolina-based bank estimates that more than a third of its electronic clients will adopt the algorithm, which seeks liquidity in ETF shares and related securities at the best price, said Charlie Whitlock, a director in the bank’s execution services team. The ETF-aX product is aimed at mutual and hedge fund managers and broker-dealers.

“This is part of the changeover from institutions sending orders to brokers to doing more self-execution,” said Paul Zubulake, a senior analyst at research firm Aite Group in Boston. “More customers are taking execution into their own hands and brokers want to provide tools directly to them.” Commission costs also shrink “when you take a human being out of the equation,” he said.

U.S. ETFs had $783 billion of assets in May, up from $582 billion a year earlier, according to the Investment Company Institute in Washington. The number of ETFs rose to 860 from 712 over the same period, the trade group said. ETFs accounted for about 17 percent of U.S. equities volume in the first half of this year, data compiled by Bloomberg show.

“The overall ETF market has grown and clients who historically weren’t investing in these types of derivatives are expanding the types of products they trade for hedging purposes or to get exposure to a particular sector,” Whitlock said.

Automated Strategy

Bank of America is giving clients access to an automated strategy it uses on its own ETF desk to handle customer orders, Whitlock said. The strategy can buy or sell the ETF, shares of companies tracked by the product, and futures, depending on the best tactic at the time. It returns ETF shares to the client.

“As we build out our electronic offering, there’s been demand from our client base for more sophisticated tools to trade these asset classes,” Whitlock said. Bank of America, like other brokers, gives customers algorithms tailored to particular types of trading or stocks to meet their execution goals. Customers often use strategies that sweep liquidity across markets to trade ETFs, he said.

They can now employ the algorithm instead of going to a human sales trader at a broker-dealer, Whitlock said. Such intermediaries make decisions about how to transact blocks for institutions, including when to commit the firm’s capital to facilitate a customer trade that would move the market or couldn’t be executed rapidly enough.

Anonymity Concern

“Customers have more concerns about anonymity and they want more control over their order flow,” he said. “This is a product customers can use to trade ETFs themselves.” He said clients would still use sales traders for difficult or large transactions that couldn’t readily be executed.

ETF-aX is the first product Bank of America is offering clients that was specifically designed to trade across asset classes, Whitlock said. It does so because shares in some ETFs don’t have enough daily volume to meet institutional demand even though companies in the index may be actively traded.

Beyond some of the most popular ETFs including the SPDR S&P 500 ETF Trust and PowerShares QQQ, “many names don’t trade as well as the underlying stocks do,” said Justin Davda, a director at Bank of America’s ETF desk. “So there may not be enough liquidity for institutions.” Broker-dealer trading desks can hedge in related futures contracts or the underlying securities and turn those trades into an ETF for the customer. “With this algo, we’ve wrapped that process into a tool and put it on the electronic trading platform, expanding the universe of algorithmically tradable ETFs for clients,” he said.

Electronic Strategies

The ETF algorithm is considered a premium product and will cost more per share for customers to use than some of the Bank of America’s other trading strategies, Whitlock said.

Brokers such as Chicago-based Fox River Execution, which SunGard Data Systems Inc. said on July 22 that it acquired, offer customers electronic strategies to buy and sell ETFs. Credit Suisse Group AG handled the most U.S. stock trading based on commissions paid by asset managers and hedge funds, according to a June report by research firm Greenwich Associates. Bank of America was tied for third with Goldman Sachs Group Inc. while JPMorgan Chase & Co. was second.

“Electronic trading has become an increasingly important part of the market, but up until now people traded ETFs with algorithms designed for individual stocks,” Davda said. “Now they can do it themselves with a product designed specifically for ETFs,” he said.

To contact the reporter on this story: Nina Mehta in New York at nmehta24@bloomberg.net.

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