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.
“The cost of holding a Eurostoxx 50 future, for example, has climbed from an average of 0.07% of the contract value since 1998, to an average of 0.45% over the last year,” reported Juliet Samuel for the Wall Street Journal, citing BlackRock (NYSE: BLK) data, in 2015.
BlackRock, parent company of iShares, the world’s largest ETF issuer, is looking to expand its footprint in the European ETF market by convincing traders to drop more expensive derivatives products for ETFs. [iShares Looks to Expand in Europe]
The move to ETFs over derivatives comes as part of a broader increase in ETF usage by institutional investors. Earlier this year, a study conducted by Greenwich Associates and sponsored by BlackRock said 46% of institutional ETF investors surveyed allocate 10% or more of total assets to ETFs with 47% saying they expect to boost ETF usage over the next year.
In a note out Monday, Mark Wiedman, global head of iShares, said, “Institutional investors accelerated use of ETFs as substitutes for futures and swaps in 2015. As banks’ balance sheet costs have ratcheted up, so too has the cost of using futures and swaps. ETFs are now typically a more efficient substitute for major global equity indices and for bond indices like credit derivatives. For instance, S&P 500 futures averaged approximately 56 bps over the last year, while our iShares Core S&P 500 ETF (NYSEArca: IVV) in the U.S. only costs 7 bps.”
Tom Lydon’s clients own shares of IVV.