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A pivotal year for the exchange traded funds industry


By Simon Gray – The second etfexpress awards comes at a particularly momentous time for the exchange-traded fund industry. It comes in the aftermath of a global crisis that left the investment industry as well as the broader financial sector profoundly and permanently changed. 

In the case of ETFs, the crisis appears to have acted as a springboard for investment by a broader range of clients – institutional, corporate and individual – than ever before. It may be that in the future, students of the ETF industry will look back upon 2010 as a pivotal point in its development.

According to BlackRock, which is today a leading authority on exchange-traded products through its highly-rated research team in addition to being parent of the global market leader iShares, last year the industry experienced sharp increases in all measures of its growth.

The combined assets of ETFs and similar products, including exchange-traded commodities, grew from USD1.16trn at the end of December 2009 to USD1.48trn last year, an increase of 28 per cent.

That’s an impressive total for an industry that has recently celebrated its 20th anniversary. On 9 March 1990 the first ETF, the Toronto 35 Index Participation Fund (known as TIPS), was listed on the Toronto Stock Exchange to track the exchange’s benchmark TSX 35 Index. It was not until nearly three years later, in January 1993, that what is generally agreed to be the first-ever US ETF, the SPDR S&P 500, was launched. The first European-based ETF did not appear until 2000.

Last year the number of distinct exchange-traded products rose from 2,672 to 3,503, or 31 per cent, while the number of providers grew from 132 to 168. The total for separate stock market listings increased from 4,856 on 45 exchanges to 7,311 on 50 exchanges. In the past year, ETF listing and trading has been extended to Portugal, Poland, Russia, Abu Dhabi and Saudi Arabia.

Total exchange-traded product assets are set to grow by between 20 and 30 per cent annually over the next three years. That would imply that the USD2trn mark will be passed some time early next year.

ETF assets on their own are expected to reach USD2trn by the end of 2012, made up of USD1trn from the US, USD500m from Europe and USD500 from other parts of the world, principally Asia.

This growth will in part come from providers tapping new markets. In the US, where ETFs have traditionally been viewed as retail products, there are signs that institutional investors are increasingly embracing them for both tactical and strategic reasons, including cash equitisation, transition management, rebalancing, and obtaining exposure to sectors that are otherwise difficult or expensive to access.

In Europe, meanwhile, ETFs are becoming more prevalent in retail markets as they are embraced by distributors such as independent financial advisers. This trend ties in with moves in markets such as the UK away from remuneration of advisers through commission. In the past this made it more difficult for ETFs to gain traction because of their low cost structure.

Cost is one of the factors that are making exchange-traded funds particularly popular among investors of all types, as well as their transparency and the liquidity offered by the ability to trade them on an exchange.

Just as importantly, the disappointment of many investors with the performance of actively-managed funds in recent years has persuaded them to embrace openly index-based products at the expense of funds that fail to deliver the alpha that their management fees are supposed to pay for.

Their popularity has been further boosted by an ever-increasing variety and range of products covering equity, fixed-income, commodity, hedge fund and other types of investment. Crucial to that process has been the role of index providers and their ingenuity in finding different ways to slice and dice the investment universe into representative and meaningful segments.

Last year the equity markets – both developed and in emerging economies – were the principal driver of new ETF investment. Fixed-income ETFs received smaller inflows, reflecting the depressed level of interest rates across most major markets, while commodity-based products also experienced a reduced level of net new assets.

Growth also brings growing pains. One phenomenon that is being increasingly seen as the industry expands is the closure of ETFs that have failed to gain sufficient traction among investors. In many cases this reflects a narrow investment focus that has not struck a chord in the marketplace. Despite the flowering of new varieties of product, the bulk of the sector’s assets are in products that mirror broad and well-known market indices.

There has also been some concern about the accessibility to the retail market of products whose complexity in not necessarily apparent to less sophisticated investors, such as certain types of product promising the inverse performance of an index, using leverage, or both.

Along with ETFs that use hedge funds as their underlying basis, these products are attracting the attention of regulators. As with other categories of financial products and services, investor education is set to become a priority in the future as the ETF label covers an increasingly diverse broad range of products with wide variations in complexity, transparency and risk.

Regulators are also looking more closely at the interaction of ETFs with the financial markets, especially after the so-called ‘Flash Crash’ last May 6, which saw US share prices plummet nearly 10 per cent in just half an hour. The US regulator, the Securities and Exchange Commission, later found that ETF transactions accounted for a disproportionate number of traders that were cancelled for being out of sync with previous values.

Most recently, ETFs have been supposedly implicated in efforts to disguise insider trading. So-called ‘ETF stripping’ is said to involve traders buying an ETF that includes stock about which they have inside information and then shorting the other stocks in the ETF. However, what this reflects more than anything is the central role now enjoyed by exchange-traded products within financial markets, making them as useful for wrongdoers as for legitimate traders and investors.

There’s no sign that the innovation that characterises the sector is coming to a halt. The rocketing of commodity prices in recent years has focused attention on exchange-traded commodities, which have become a separate market segment in their own right on many exchanges.

Meanwhile, a number of asset managers continue to experiment with the idea of actively-managed ETFs, although there’s a long way to go before they start to challenge the preponderance of index-based products.

As the exchange-traded products sector continues to develop over the coming months and years, etfexpress will intensify its efforts to provide unrivalled coverage of the industry, its trends and participants.

Drawing on the experience of approaching a decade of coverage of the global investment industry, we will deliver up-to-the-minute coverage and specialist comment and analysis of the developments shaping the exchange-traded products sector and its appeal to investors around the world.

Since its launch six years ago, etfexpress has played a leading role in focusing the attention of financial sector professionals and a diverse range of investors on the sector’s leading product providers and distributors, and the markets in which ETFs and other products are traded.

Our focus on specialist areas of the investment industry has attracted a global audience of over 5,000 daily readers around the world, including institutional investors and wealth advisers, which is why it is appropriate that we should draw on their experience and knowledge to determine the destination of our annual awards.

The award results are based on more than 1,000 responses from readers. In calling on readers to tell us whom they thought should be the etfexpress Awards 2011 winners, we asked them to take into account a variety of factors including innovation, consistency, depth of knowledge and transparency – all characteristics that investors demand more than ever in the much-changed global financial environment.

Please download a copy of the special report from here: etfexpress Awards 2011

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