Inside Jane Street's ETF trading

With the accelerating adoption of ETFs comes the need to better understand how they are traded. In this Q&A between Vanguard Senior ETF Capital Markets Specialist Dave Sharp and Jane Street ETF Strategist Jess Clancy, you'll be able to take a peek into the ETF trading ecosystem to help you and your clients better understand how to approach important ETF trades.

Jane Street is one of the biggest ETF traders in the world, with offices in New York, London, Amsterdam, and Hong Kong that together traded an average of $16.8 billion in ETFs per day last year. In addition to ETFs, Jane Street trades a wide range of financial assets including equities, bonds, commodities, options, futures, digital assets, and currencies. It makes markets on more than 200 electronic exchanges and trading venues in more than 45 countries.

Can you provide a brief overview of Jane Street's ETF trading activities?

We are one of the most active ETF liquidity providers in both the secondary and primary markets. We facilitate trades of all sizes for clients, whether it's a small order that we provide liquidity to on an exchange, a large block trade that we execute with an institutional investor, or in our capacity as a wholesaler. We're a registered market maker in over 2,700 U.S.-listed ETFs and serve as lead market maker for roughly 20% of them.

As the ETF world has expanded in the last 5 to 10 years, how has the ETF trading landscape changed?

First, the growth and overall adoption of ETFs has been significant. Global assets under management in ETFs have more than doubled over the past four years alone, surpassing $10 trillion by the end of 2021. We've seen investors use ETFs as core portfolio building blocks as well as for more tactical positioning. The growth of ETFs in model portfolios has also been a major tailwind for adoption in recent years.

In particular, the market has seen strong growth in the launch and adoption of fixed income ETFs. Assets in U.S.-listed fixed income ETFs have grown by more than 300% over the past five years.1 In April 2017, fixed income ETFs accounted for $8 out of every $100 of ETFs traded—by April 2022, they accounted for $13 out of every $100.2

How has this growth affected ETF trading? More big trades, maybe?

Definitely. But first, when it comes to trading, investors are increasingly comfortable with the different execution strategies available to them, particularly regarding bigger trades. In a recent survey we conducted with Risk.net, 70% of respondents reported that risk trades were their most commonly used strategy. That's consistent with what we see on the desk. With a risk trade, the client trades a block of shares directly with a market maker.

When a client is looking to buy a large block of ETF shares, how does Jane Street approach the trade?

There are a number of factors market makers consider when pricing a large trade for a client. First, they have to have a sense for how they'll manage the risk of the trade after it is executed. One well-known risk-management technique for ETF market makers is to buy or sell the underlying instruments while redeeming or creating the ETF to collapse the position.

Can you explain what collapsing the position means?

Collapsing the position simply means that the creation or redemption takes the market maker’s short or long position in the ETF to zero. When this happens, the liquidity of the underlying components of the basket is the main pricing consideration, along with any commissions or taxes related to trading the underlying holdings.

That said, market makers don't have to collapse positions this way. They can hedge with derivatives or other correlated instruments, including other ETFs, or they can hold the risk on their book in anticipation of offloading it in the future. However they choose to manage the risk, their expected cost in doing so is a major factor in pricing.

Secondly, market makers will consider how their book is positioned. If they already have a long position in the ETF in question, or in other instruments tracking the same exposure, the market maker's book may be more competitive on the offer side than on the bid side. Conversely, a short position might see the market maker price the bid side of its market more aggressively. If the ETF is trading at a discount or premium to what the market maker estimates to be its fair value, that will also tend to skew its market to one side or the other.

These variables are why it's important to choose a competitive mix of market makers when getting a quote for your trade.

As clients and asset managers continue to adopt ETFs, has Jane Street discovered any best practices to help achieve the most competitive execution possible?

In general, we always want to support clients with a trade that is aligned to their desired outcome. When approaching a trade, investors often consider a few factors, such as the size of the trade relative to the ETF's on-screen liquidity and its underlying liquidity, as well as their urgency to get the trade done. For example, an investor that has high execution urgency and a large trade relative to the ETF's average daily trading volume might consider making a risk trade where they can execute immediately while minimizing market impact.

Information leakage is another important consideration.

What do you mean by information leakage?

Putting market makers in competition helps ensure competitive quotes. But sending requests for quotes to too many market makers means divulging information to counterparties who may not stand a reasonable chance of winning the trade—that's what we mean by information leakage. Additionally, we encourage clients to request two-sided markets—i.e., both bids and offers—even though they're only looking for one or the other. If investors aren't sure which market makers might be competitive for a particular ETF they're looking to trade, they can always reach out to the ETF issuer's capital markets team for guidance.

 

1 Jane Street calculations based on Bloomberg data from March 30, 2017, through March 31, 2022.

2 Jane Street calculations based on Bloomberg data.

 

Notes

• For more information about Vanguard funds or Vanguard ETFs, visit advisors.vanguard.com or call 800-997-2798 to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.
• Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.
• All investing is subject to risk, including possible loss of principal. Diversification does not ensure a profit or protect against a loss.
• Bond funds are subject to interest rate risk, which is the chance bond prices overall will decline because of rising interest rates, and credit risk, which is the chance a bond issuer will fail to pay interest and principal in a timely manner or that negative perceptions of the issuer's ability to make such payments will cause the price of that bond to decline.