Exchange traded funds have been a disruptive innovation in the financial industry, cutting into mutual funds’ market share. Now, as the investment vehicle grows in size, ETFs are beginning to muscle in on the derivatives market.
There are signs that some investors are increasingly turning to ETFs as alternatives to futures contracts to gain exposure or insure their portfolios against risks, reports Rochelle Toplensky for the Financial Times.
“[Our] ETF usage has gone up, mostly because the cost has come down and the variety of ETFs has increased,” Shaniel Ramjee, investment manager with Pictet’s multi-asset team, told the Financial Times, comparing the cost of ETFs with futures on a cost basis.
ETFs are still a nascent industry, with $2.85 trillion in total assets under management as of the end of February. In contrast, exchange-traded derivatives holds $267 trillion, according to Bank for International Settlements data, or $66.5 trillion market capitalization of listed equities listed globally, according to the World Bank.
The rapid growth, wider acceptance and low fees have helped ETFs garner broader attention. The ETF industry offered about 3,882 at the end of 2015, and the growing competition has helped push down fees. Meanwhile, the broad coverage and rising popularity of the investment vehicle has diminish bid-ask spreads on trades. Consequently, the improved liquidity and range of investment options have attracted institutional and retail investors to consider ETFs.
“The growth in the short term is going to be in equities given that is where people are more comfortable with ETFs,” Andrew McCollum, consultant at Greenwich Associates, told the FT. “In the US, we are starting to see real growth in the fixed income side and I would expect we will see that in the longer term in Europe and in Asia.”
[related_stories]As investors grow more comfortable with the ETF investment vehicle, people will begin to implement ETFs in more complex strategies.
“The biggest shift is the breadth of investor type,” Samara Cohen, US head of iShares Capital Markets told the FT. “Hedge funds, asset managers, pension funds, insurance companies are looking at ETFs alongside futures and swaps to determine the best economics for their strategy.”
For instance, according to a Greenwich survey, two-thirds of Europe institutions and over three-quarters of U.S. institutions believe an S&P 500 ETF provides more effective beta exposure than S&P 500 futures for a fully funded S&P 500 position, citing ease of use and low costs as the main reason for switching away from equity derivatives.
Meanwhile, as ETF fees fall, the cost to renew or roll futures contracts rose in early 2015 in response to structural market changes and new banking regulations.
As institutional-sized investors shift away from costlier derivative options to hedge their positions, the ETF industry could continue to experienced greater growth from a new group of investors.