2022 Perspectives for the Public Sector

Citi Perspectives for the Public Sector 21 manager with an established track record. By using the ETF, the client effectively traded several billions of dollars’ worth of bonds at mid-levels, meaning the execution was cheaper and faster than if the client or a traditional mutual fund had traded the bonds directly themselves. All trades settled successfully in T+2. • Sovereign wealth fund A sovereign wealth fund wanted to invest in the CNY-denominated China bond market quickly but faced a lead time to be able to trade China bonds directly. It was already set-up to trade cash equities and so turned to a CNY China Bond ETF to deploy risk while it set up with Bond Connect. A granular selection of China bond ETFs meant that the client was able to pinpoint the section of the market it wanted exposure to — in this case government bonds rather than policy banks. The client can now trade bonds directly but maintains the ETFs for its core beta holding and has tilted its portfolio by adding specific individual bonds. Greater and more varied use of ETFs has led to improved two-way liquidity, that in turn has created additional opportunities for ETFs to be used as capital markets instruments: • A healthy listed options market on ETFs allows clients to generate additional yield through overwriting on their ETF holdings in exposures such as gold. Figure 3: Institutional use cases Source: Citi Business Advisory Services Factor-driven ETF or index exposures support efforts to shift portions of the portfolio away from active managers – emerging options to capture idiosyncratic exposures could further this trend - Factor Exposures: A full set of factor-driven exposures can be obtained via indices or ETFs – geographic, sector, style, and technical factors - Exposure Extension: Emerging categories of actively managed and thematic ETFs and indices are extending the ability to capture idiosyncratic or alternative exposures The ability to redeem ETFs in kind for the underlying securities is leading to a new set of trading options to better manage liquidity for both investment managers and dealers, particularly in bonds - Investment Managers: (a) Leg into securities to take advantage of basket pricing & (b) Replace securities, but maintain exposure to reduce liquidity concerns - Dealers: Sell risk and reduce balance sheet (or take-on risk and increase balance sheet) Uptake of ETFs and index funds for cash management are benefitting from interest rate increases and a growing set of both rules- based and short duration actively managed bond funds - Short - duration Instruments: Short-term, investment grade debt which can offer enhanced yield with lower risk through security selection - Liquidity Sleeve: Avoid performance holiday by having pool of liquid securities that can easily be exchanged for cash Depth in key ETF liquidity pools, the emergence of options and swaps on those ETFs, and new ETFs that isolate specific exposures are expanding hedging and risk management opportunities - Position Level: Used as a substitute for security or index futures, swaps, or options - Portfolio Level: (a) Overlays to help address unintended correlations across external managers & (b) Alternative to all-or- nothing execution to exit positions ETFs were created to augment index funds and help institutional investors maintain a liquid market exposure while selecting a new manager rather than leaving their funds in cash - Cash Deployment: This allows cash to be deployed into the market and the portfolio to maintain a target exposure between allocations to external managers and avoid a performance holiday Portfolio Construction Transition Management Hedging/Risk Management Cash Management Liquidity Management Return Seeking Exposures Portfolio & Trading Tools Expanding Set of Beta Strategies