Why ETFs Are Taking Territory from Futures | ETF Trends

Due in large part to the lower fees associated with exchange traded funds, more professional traders are turning to ETFs to replace futures, swaps and other derivatives products.

Traditional ETFs track underlying indexes, which is made possible through the share creation and redemption process. ETFs are also becoming a large force in the oil commodities market, accounting for a third of the most active oil futures contracts. Investors have been buying up oil futures-based ETFs in an attempt to catch a falling knife after the 2015 plunge in West Texas Intermediate oil futures.

ETFs posted another stellar year of asset growth in 2015 and one of the catalysts for that growth was professional traders ditching higher-cost derivatives in favor of lower-fee ETFs.

“Among new drivers of growth were investors who used ETFs to replace derivatives including futures and swaps. Such conversions brought in $10 billion to BlackRock in 2015, or about 8 percent of the funds it attracted in its ETF business. The trend away from derivatives is helping to buffer slowing expansion in so-called smart beta products, which BlackRock and others have targeted for future growth,” reports Yuji Nakamura for Bloomberg.

Faced with increased regulatory burdens and higher capital reserve requirements, some financial institutions are turning to exchange traded products as replacements for pricier derivatives instruments. Institutional investors, including endowments, pensions and sovereign wealth funds, have been embracing ETFs as lower cost alternative to futures and swaps. Earlier this year, analysis from Bank of America Merrill Lynch noted that long-term investors looking for $100 million worth of S&P 500 exposure would save $250,000 in annual fees by opting for ETF exposure rather than futures.