Invesco Ltd. (IVZ) Earnings Call Transcript & Summary

Yes. No, I think you guys provided good things. Just to wrap up some things that I think were really interesting, too, is the criticism always comes from the wrong angle, right? Everyone is like, "Oh, well, ETFs are going to disrupt the primary or whatnot." But -- and there's a good question that came in from somebody about the efficiency of secondary market trading, right? So you guys, I'm sure, during March, you see more of a pickup in secondary trading. And something you had mentioned, Oleg, they actually serve as a buffer, right, to the primary. Because think about it, even if the ETFs didn't exist, the actions are going to be the same. If someone wants to sell their high-yield position, they're going to sell it, whether they're selling the actual bond or they're selling a mutual fund or whatnot, although sometimes just the crossing of the secondary market relieves some of the pressure off the primary. And I think that's the right way to look at it. And the other thing you mentioned about the bond pricing services, I think you can see that a lot of it was stale, and I think a lot of that is apparent in some of the mutual funds, too. A lot of these were very slow to readjust and, like you were saying, is the relying on stale pricing services, bond pricing services, while the ETF is actually -- has a market in real time. So a lot of times, these discounts, they might optically not look good, but they are potentially warning of a potential liquidity in the market that are actually serving as a better proxy for what's really happening versus some of these lag pricing services.

Exactly. And then maybe just to echo one of the questions -- or just to address one of the questions on the panel we just received. And sort of I'd like to briefly exemplify it by providing an example. Because we are, as issuer, obviously, we're very much aware of the ongoing sort of dynamics in action. And we very much critically looked into the pricing of underlying bonds and sort of the market functions and basically just establishing whether or not there are some efficiencies to be gained. So I'd like just to maybe kind of provide 2 hypothetical examples. There are actually underlying bonds behind these examples, but I'm just using it as a hypothesis. So one bond was actively traded, and the second one was less actively trade. So [ let's go first ] on the left-hand side. So in theory, we understand that the more actively bonds -- the more actively bond is traded, the more reliable the prices can be established with because there is essentially a live market, as you said, Tom. So for instance, like in the first week of March, in the less actively traded bonds, which we see on the left-hand side of this chart, had trade pretty much every day. And sort of the last price was pretty much in line with the transacted price, which was transacted -- which it was transacted at -- on the market. By the third week, however, we saw that the last price has started diverging, some by 5% to 10% that math that is essentially remaining above where the investors are actually trading this bond in the market. So -- and that's why essentially, the mass of ETFs, which helped this bond, have been inflated, right? But that wasn't really the true reflection of the market dynamics. So -- but the ETFs being traded actively and sort of why when the market would have traded at a steep discount given that, right? So as liquidity providers -- so clearly, we mentioned that. So liquidity providers who we needed to review security would deliver this multiple kinds of physical delivery. And then essentially, we ultimately would have to sell it in the market significantly below the market price. And that's why the authorized participants would price the ETF correspondingly at a discount. So now -- and that's all fine in terms of securities, which trade less actively. So for bonds which are on the other side, bonds which traded more actively, with more sort of dynamic, there we see it on the right-hand side, right, the bond pricing agents had more than 50 TRACE bonds. So you basically have price levels on TRACE, the Trade and Reporting Compliance Engine, just think of it as one big printing machine for all of the corporate trade. So the bond, now priced, seems to be okay and on track to potentially do a transaction, like more weighted average price kind of trades for most of the time. But there still was a significant dislocation in the third week of March. So for instance, we saw that the price of this bond increased day on day on March and May 19, which was the eighth worst-performing day for the investment-grade universe. So for us, that actually made us think a little bit, right? So -- and in a nutshell, we deduced and concluded that this actually highlights the need, and that's basically to address one of the questions in the panel, that highlights the need for enhancements in fixed income market structure as well as the improvements of the pricing methodologies for fixed income ETFs, right? So we feel that more OTC market should have a central reporting of trades and prices, especially in Europe because we don't have this kind of -- not as fully fleshed ideas, this consolidation of the cake. And the prices should be broadly distributed. We see all market participants with minimal delay. So the time lag should be reduced. So additionally, we think that there should be more reliance on the traded prices than stale or essentially nonexecuted dealer quotes. And that would be -- from our perspective, that would be, to some extent, an alleviation for the industry. And saying -- addressing the part of the question that ETFs broke down. Well, from our perspective, and ETFs in this market environment, they actually -- they helped out the market sentiment by executing to establish and sort of to calm it down and quell a little bit because they essentially have become the price discovery vehicles for the underlying market and basically stepped in to fill the void from lack of this continuous price discovery in the underlying bond market. And that -- for investors, that should serve as an assurance that they always will be able to express their investment intentions, just to trade in, out or just tweak the position.

Great. Thanks, Oleg. Let's move on because I want to -- I still want to talk about gold and some product development. But one thing is for you, Kai, that I think is really interesting. In March, this is just overall trading dynamics, there was a surge in trading. It was record volumes. Depending who you ask, there was -- I see stats about a little over EUR 330 billion traded in March. That's about double the normal monthly average. In terms of breakdown of investor bases, what did you guys see in March? Was it mostly institutional? Did you see maybe more retail come in? Was it going through exchange, through OTC-like RFQ platforms? You don't have to get into very specific details, obviously. But what were some of the investor base breakdown you saw in March and some of these volatile periods?

So obviously, take one exchange trading in Europe accounts for typically around 20% to 30% of all ETF volumes. So you know that most of the ETF volume that's been traded in Europe, TRACE, OTC, on platforms such as [indiscernible] or Tradeweb, where, in particular, institutional clients expect the trading interest, trading big box sizes. As you can imagine, March, and to a certain extent also April, has been extremely [ billion ] volatile period in the market, which translates, of course, to lots of activity on our side as well. What we did see, obviously, that the big volumes we are trading in the OTC space or is -- particularly on some exchanges, also retail volumes, the on-exchange volume have been picking up significantly. What's interesting to see is that if you look, for instance, at spreads, but particularly on the on-exchange [ broad ] side, spreads for oil products increased a lot, which did not translate as much into a spread increase on the OTC side, which just gives some argument for the fact that particularly obviously trading on different MPS platforms for institutional clients is a very robust and also transparent way to execute. As Oleg mentioned before, any issue would have a serious range of authorized participants and market makers on exchange and also in the OTC space, which basically provides a transparent and competitive environment where everyone is extremely busy, but everyone is also making sure that pricing is fair and credible, that we can provide actionable and credible quotes to investors more or less 24/5, in that sense. And we -- and me and my colleagues, I believe, as well as our competitors, we have been spending some long days in the office and also at home. Know that during the month of March, many companies moved part of their teams in a working from home environment. So that our team, on the institutional trading side, and in addition to these, say, the market days of extreme volatility and market stress, we had to cope and adapt to a new situation where luckily, our infrastructure is very robust and very good. So we can actually execute our jobs from home, from the home office. But I'm still keeping in my home office since the day and for the foreseeable future. But basically, it is possible. And if you look at the volumes that have been trading, it has been tremendous basically on all channels.

Yes. Great. That's probably what I expected. And then keeping on this theme about institutional versus retail, one thing that really sticks out, and there's a lot of attention this year, is on gold funds, right? So flows this year, 3 of the top flow, through to the 4 top products in Europe flow-wise for all gold funds. GLD in the U.S. just hit record assets. There's just been this massive transition towards gold. Obviously, you guys at Invesco, too, you guys run a big gold fund. What -- from when you're speaking to the clients, what's causing the sudden interest in gold this year? It's not like these products are new. But what are some of the use cases and interest cases that you're seeing for the run towards gold?

Yes. That's a very good question. And definitely, action in the gold space has been really, really very dynamic year-to-date. So I mean, to the point of the intention of clients, why are they investing in gold? Because basically, gold has increasingly been accepted as a portfolio diversifier, right? I mean, there is -- there are a lot of studies coming up and so on and not basically simulated the allocations have like -- gradually, it's been simulating the allocations to the asset class. However, the global, like you call it, '19 pandemic crisis pretty much explosively, very much explosively fueled this kind of safe haven investment demand for gold. And so basically, as the scale of the pandemic was clearer and clearer and the potential economic impact became clearer and clearer, when all of that started to emerge, the investors started looking for security increasingly and also essentially reallocating or treating the portfolios, pouring money into gold. So the gold-backed ETCs attracted huge inflows this year or the year-to-date. Somewhere around EUR 12.5 billion came into the space and the -- pushed the global -- like the overall European holdings to around EUR 90 billion right now. So it's been tremendous success for the product range. But also, that's pretty much kind of reflective of the ongoing turmoil and turbulence on the market.

So one thing that you can just -- yes, I was about to say, maybe briefly, when you see demand spike like this, what is some of the impact -- I know you have some great data here, some of the impact you had on spreads around the underlying market and some of the things that you saw in March in those coming months when there was a big spike and run towards gold. .

Yes. Tom, that's a very valid question, very interesting, very topical for the gold market since what we saw in the underlying market was pretty much unprecedented. And having spoken to market veterans, no one has seen anything like that happen like in the past. So just before diving to the spreads, I'll just quickly diverge and talk what sort of fundament has been taking place in the gold market in March and what sort of consequences did it have on the dynamics. So the phenomenon itself was a conflict and dislocation between the London OTC spot gold market and the New York COMEX futures market. It's basically just what happened, quickly recapping this. The price differential like in March, towards the end of the March, so the 24th March, the price differential between London spot gold, the physical gold market, and the COMEX active futures markets in New York, which is also known as -- the entire contract known as exchange for physical, so abbreviated as EFP, both physical gold and the futures market are pretty -- usually are very much overlapping, right? So they're in line with one another. But in March, they started to widen out. So historically, this exchange for physical has traded in a very relative yield, tight and in a predictable range. More recently, it was like around $2 per ounce, and that was basically governed by the physical arbitrage costs. So if COMEX futures were becoming -- to trade at the premium to the London OTC market, so a trader could enter the market and close out the trash by selling the future and essentially buying the spot market. So towards the end of March, however, as we all heard, Swiss gold refineries, so in Switzerland, which are the biggest in the world, right, took some operations off-line. And then the network of the commercial flights, which are used -- usually used to transport gold around the globe, decreased. So the exchange for physical rate jumped here from, and now bear with me, from $2 to $70. And these 2 markets became very much dislocated. So what was causing it? Well, that was mainly driven by the so-called perceived shortage of the COMEX deliverable investment gold bars located in COMEX exchange, New York bonds. So basically, as the logistical limitations across the globe sort of started to increase and they impeded the potential for physical close of this arbitrage, so the gold simply could not be flown around the world to deliver from one location -- to be delivered from one location to another and just to close the arbitrage. That basically did cause some issues for the trading community, who would usually sort of trade lower-quality physical gold in London spot market and offsetting the position just to be priced risk-neutral with the COMEX futures. So -- but on the other hand, the -- yes, very much advantageous were like the positive effects, which gave it out or emerged or were learned and sold and then investments we're aware of, were essentially that the physically backed ETCs displayed much lower premiums and discounts. So the dislocation and the volatility of the premium discounts of the physically backed ETFs or ETCs were not as bad as the volatility of the futures market. And that allowed for -- well, for investors, it's essentially allowed for more cost-efficient engine exit points, and that was pretty much driven by the authorized participants or the so-called bullion banks and market makers, such as Flow Traders and the other guys, who have the ability to directly trade the physical gold market and sort of -- without exposing themselves to the futures market. So what impact it did have on spreads? I know you told me you wanted to do the polling question, but I'll do the quick spreads presentation. So looking at spreads, we -- as I said, we work closely with the authorized participant communities such as Flow Traders guys, and we basically, well, leverage their proficiency and high expertise in this segment, and we basically ensure good trading conditions of our products. So the result is pretty much evidence on the chart. So our gold product stays within the client spread range, pretty much in line with the underlying gold or even inside of the gold spread. So for investors, what it meant for investments, there was much more efficiency to trade in physical ETCs or ETFs, so to say, rather than trying to essentially access the market via the futures positions.

So let's do this because you brought up the polling question, which is interesting. And Kai, I want to bring you in here. I'll just pull it up and that -- because what's -- because obviously, there's been this interest in gold. But what we're also curious to hear is what else, what other themes are the audience looking at the share, ESG, fixed income we addressed, gold can form the commodities, smart beta/factor investing. We have a follow-up. Just curious what maybe is going to be, for the remainder of the year, kind of the back half of the year, what are going to be some of the investment themes that you're going to be looking at? [Voting]

I'm sure we can talk. Kai, I know ESG is something that comes up a lot. What are some of the conversations that you have with more clients? And how strong do you think the interest for ESG is? I know that sounds like a silly question. Obviously, it's strong. But just curious what are some of the questions and interest levels that you're getting for this type of strategy?

Thanks, Tom. I believe ESG and also what we discussed before, gold, are basically the only segments of the market where we had continuous inflows throughout the whole year, including March. So we do see, particularly in the ESG space, we do see increasing interest from our entire counter-body base. So that includes pan-Europe but also Asia and the U.S. It's -- I believe it is a topic that is, on the one hand, coming up in investors' mindsets much more frequently. It was traditionally driven by, say, the pension fund side. It has been driven by many of the Nordic markets, which in the last years have been initiating some of the light [ haul ] steel in this space. So basically, a single product to be launched, where large institutional investors were backing these products and stepping up and saying, "Okay, this product, this universe is ESG for us. We really consider this to be an investment vehicle that satisfies our strict criteria." And interestingly enough, during the crisis, in particular, when the recovery started, we have seen a lot of sort of replacement trends where institutional investors that have been holding, say, a plain vanilla ETF portfolio, dredging some of the standard benchmarks, have been selling these ETFs at the beginning of the pandemic. But that when the market turned, then they have been reinvesting again. They have been buying the ESG or SRI equivalent of this product. And this partly has been driven by the fact that ESG products, as we can see it, the results are very interesting for investors. People are looking at it. It is something that is in the news, that also the next-generation of investors, if you look at the millennials, about the next generation of retail and institutional investors coming to the market, they do want to have some kind of environmental, social and government criteria as part of their investing strategy. And when these replacement deals are happening throughout the year, we have been looking at those deals particularly closely. And what we found out is that if you look at the total costs, they are almost equivalent. So there is, in particular for the, say, the lightest implementation of the ESG, there's always now a cost premium for moving from a standard benchmark to something that is ESG-screened that have some corporate ESG filter to it. And I believe this makes it really attractive for investors. And looking at the performance of those vehicles and also the tracking error, so to say, the standard benchmarks, those products are performing relatively well, sometimes even outperforming the standard benchmarks because they have been excluding some companies that had some troubles in the past already. Let me say this, a fairly recent example is Volkswagen. Many of those products have excluded Volkswagen before the diesel scandal hit, which basically, even in a relatively calm year like last year, have seen an outperformance versus the standard benchmark. And I believe this is a story that is just emerging, that it's just beginning. And you also can see some consolidation in the ESG rating agencies. My personal opinion is that, at some point in time, at every stock, every investment vehicle will have some kind of an ESG rating into it, which then empowers investors to construct portfolios based on certain criteria. And it will become certainly a standard in investing, which you can also see there in the polling result with almost 60%, yes.

Yes. Exactly. That's what I was going to say. You can see it, and this is not -- we know the results. Obviously, there's been a focus on ESG. And even if we look at the breakdown, I have a chart here of how the industry is set up, right? So this is probably even closer to 5% now for ESG. Most of it is in traditional index, right? You have another 7% or so in smart beta active, which is still pretty small, but it's a bigger push in the U.S. But ESG, 5% of the market here, it's much bigger than the U.S. The U.S. is still only about 1% of the market. So nonetheless, this small pie of non-index strategies is still pretty small. So there's still some room for growth there.

If you think about it, it's only 5% of the assets in Europe, that's true. But starting from the last year, ESG flows are almost 7%, 15% of the net flows. So we do see a strong growth. And if you look at the growth domain that makes up of ESG over the last couple of years, you can see it has been a very consistent transition to ESG, which basically is neutral of the market flows because, as I said before, you do see a lot of the switches from the standard benchmark into the ESG benchmark. And of course, Europe is at the forefront of it, but I believe it also will translate in other regions. And also asset class as well, ESG does not only imply equities. It's also very strong in fixed income. We're just also adopting ESG principles to more, say, more frequently as we continue new issuances that also have certain ESG or SRI criteria applied to them.

Let's -- just to be cognizant of time, let's wrap up with the last thing, Kai. Everyone's favorite discussion, regulatory issues, CSDR. So obviously, with COVID and some of the things, it's been delayed. But can you maybe just give us a quick update on where this stands? And I think I was going to have a follow-up question for that. When this does get fully implemented, what kind of impact do you see it having on total cost of ownership, on trading spreads, et cetera? If you could just give us an update on CSDR.

Yes. Just in the aspect of time, I just want to make it really short. So basically, CSDR is a regulation that was supposed to come into force in autumn this year, Q3 2020. It addresses an area which has mostly been overlooked in the last years, which is settlement. As you might know, particularly the OTC market, the settlement discipline in Europe is not as strict as compared to other regions, and we have lots of settlement delays. We have lots of nonstandard settlements. And with CSDR, basically the European regulator is trying to address these issues and also enforce stricter settlement discipline. And they are applying 2 main mechanisms for it. On the one hand, every trade that settles with a certain delay after an initially agreed settlement date will subject to a mandatory penalty between 0.1 and 1 basis points, depending on the liquidity of the security. We estimate that most ETFs will likely to be considered in the liquid security space. That means for every ETF trade that's 1 day old with you, the first responsible for it has to pay 1 basis points per day. Now this is mandatory, and it will be collected by the CCPs or CSDs, that is the central security depositories or the central clearing parties. It is not to be collected by the market participants, by the buyer or the seller of the security. It is being collected by, well, the depository agents. If the trade still doesn't settle after S plus 4 or S plus 7, again, depending on the asset type and liquidity, there will be a mandatory auto-partialing. So every security that the selling investor has will be ultimately partialed to the buying investor. And if this still doesn't settle the deal, there will be a mandatory buying, which also will be enforced by law. So from a market structure perspective, this is a big change of paradigm. And I believe this will be having quite a big impact comparable to something that we have seen with MiFID II. And for us, as market maker, of course, we are big advocates of this change because we are as well part of a settlement system. And we are also suffering from delays in settlements when OTC counterparties are not delivering shares to us. And in this respect, we do hope that this change will obviously improve operational excellence. And we do see this as an exercise of operational excellence, particularly in an area of back and middle offices, which has been overlooked in the last years. And this requires, of course, more strict settlement, and this requires more strict matching of trades, sticking to the same settlement instructions. And if you go back in time and use like some of the data, the amount of buy-in that has been executed, and there's some data from 2017 -- 2014, sorry, and that estimates that there were 1.8 million buy-ins in Europe a year worth then more than EUR 2.5 trillion. If only a small percentage of these will be translated into the CSDR by the regime, this will be a very expensive exercise. And something that is very important to understand, this regulation covers buy-side and sell-side. So even the asset management community or the private bank community, they will also be subject to it. And there are some, say, initiatives of trying to move OTC trading to CCPs or central clearing parties, which could alleviate some of the problems and some of the issues that the community is facing by standard netting of trade and a centralized pool and not different capital implications. But this is still to come. Now with COVID-19, as we said, it is for now most likely postponed to the first quarter of 2022, which gives all of us -- gives us some time to do our homework, where we can only urge to buy-side community to look into this regulation already and look into particularly the operational processes that are contributing to this factor. And to answer your question, how will this be affecting quoting and pricing? Of course, on our side, we expect that our growth that we provided to the market-based OTC or exchange are reflecting all risks and/or operational problems that we face in the entire value chain. So we will be incorporating in our spreads a certain likelihood of having to pay a penalty for a non-settling trade, a certain likelihood of a certain trade being subject to a buy-in. So this obviously will lead to a product discrimination, understanding the settlement discipline also of the counterparties, the settlement quality, if trades settle on time. And this, basically particularly in bilateral OTC trading, can lead to a situation where growth will be trading at a different spread than before. Some of the examples that are quite prominent are, for instance, ETFs that track markets that are closed. Think about something like Chinese New Year, where the underlying market is closed for extended periods of time, where creations are simply not possible. Well, as market maker, we still try to provide and offer quotes and allow investors to express and trade Chinese ETFs that have been trading in Europe. However, unless we have inventory or can borrow this certain ETF, we will not be able to create our shares. So either we have to agree on a settlement date that's far in the future where we can make sure to have accumulated those shares to deliver, or we do have to price in a certain premium for potential penalties or even buy-ins that might be subject to these transactions. So there's still lots of questions that have been -- that need to be answered. And I believe one of the reasons why it's postponed again is because ESMA needs to fully understand all the mechanics that are contributing to these parts. But nonetheless, it will be an exercise with the regulation, which is going to have substantial impacts on market structure for ETFs. I personally believe it will improve the settlement market, it will improve the market structure. It will get the European market structure closer to the U.S. market structure, where with ETC, we have a more efficient settlement process in place. And I do hope it will -- and overall, it will improve the quality of the ETF market a lot.

Thanks, Kai. And you already addressed the question, so you already rolled into Q&A. Let's just keep it going. Oleg, there's one for you on gold. I'll bring it to you. But it's just a question on create. Has there been any type of shortage or anything with new creation for units in ETCs, especially in gold ETCs? Is there anything that you're seeing on your end or any concerns there?

Yes. Tom, I think I've been answering live to people on the panel as well. Explicitly on that one, let me just quickly see -- go to one of the slides to address it. In here, basically -- well, the main knock-on effect of this gold market dislocation was essentially that the futures and -- well, the futures market started decreasing essentially. The futures market on the COMEX in New York has been posting muted volumes of futures for 2 months already. And what we're seeing is basically that this dislocation scared the bullion banks, where the authorized participant for gold ETCs would essentially trade, create and redeem their gold ETCs to move some of their positions from New York futures market into the local London over-the-counter market. So it's basically -- so far, it's much realized, as I already said, in a slower futures market on COMEX in New York and gradually increasing OTC market in London for swaps and forwards, which are used to hedge positions in London, have been turning upward. So the gold market is being accessed directly in London, the physical market. So that's basically what -- exactly what we saw during this stressed period in March when the bullion banks and market makers traded both the hedges and the spot gold market without exploiting themselves to the dislocation of COMEX futures. And by doing so, they were easily facilitate -- could easily facilitate the creations and redemptions of our gold products. So there wasn't any disruptions, no frictions. And as you saw on spread levels, the market was trading with a very high degree of quality.

Thanks, Oleg. I think, unfortunately, we have some other questions. Maybe we can answer them off-line because we're already pushing up on the hour mark. So I think it's a good place to end it. We had a lot of content. We went over on time, but it was just a lot of good content. So I want to thank everybody for staying tuned in. So first of all, I'd like to thank everyone who dialed in and for joining us. And I also would like to give a special thanks to our speakers, both Kai and Oleg, for sharing all of their insights. I hope everyone found this insightful. Hope everyone has a great day, and we hope to see you again soon.