A Roaring Trade

The global exchange traded products (ETP) industry is booming. Worldwide demand for exchange traded funds (ETFs) soared in 2010 as more investors, both retail and institutional, learned about the benefits of these versatile financial instruments. Products and assets under management (AUM) grew by 26.6% in 2010, according to BlackRock’s year-end ETF Landscape. The asset manager reports that growth has continued thus far in 2011, with worldwide AUM as of the end of January rising to more than $1.33 trillion with the number of products surpassing 2,500 in January 2011.

With the global ETF industry expected to grow more than 20% annually for the next three years, and AUM for all ETPs expected to surpass $2 trillion by early 2012, Markit sat down with ETF industry leaders at roundtables in Paris in December 2010 and New York in January 2011.

Armins Rusis, Markit’s executive vice president, led the discussion in New York, while Bernie Thurston, managing director of Markit, hosted the Paris roundtable. Both meetings sought to assess the major issues confronting the industry, what was being done to solve the problems and the overall outlook for ETFs globally. The roundtables were notable for bringing together ETF sponsors on the sell-side, their buy-side customers, the investment advisers, as well as the authorized participants (APs), or traders, involved in the creation and redemption process that makes ETFs such a transparent, flexible and cost-effective investment tool.

What’s inside the fund?

One of the major benefits of US ETFs over other portfolio products, such as mutual funds and hedge funds, is
the transparency of the portfolio. This transparency results from the process undergone to create shares of the ETF. Brokers who bring shares to the secondary market, known as APs, need to trade a basket of shares of all the stocks in the portfolio in order to receive shares in the ETF. To facilitate this, the fund must post a full account of its holdings every day after the market closes.

This transparency can be difficult to achieve, particularly in Europe. Fabien Dornier, a partner at Ossiam in Paris, said that because many European ETFs are synthetically replicated, it can be difficult to see what is actually inside these funds. Additionally, in Europe, due to the region’s market structure many securities are traded in the over-the counter
market. Whereas in the US, exchange traded products are typically created from securities openly traded in the secondary markets. This difference in execution could also impact actual fund expenses. However, participants at the European roundtable noted that a fund’s performance would expose suboptimal transaction costs.

The transparency dichotomy is due primarily to a fundamental difference in the European ETF industry’s structure. While most ETF issuers in the U.S. are asset managers, most European issuers are banks. The market is quite different in Europe because the banks and brokers are the fund managers, and the ETFs reflect this. ETFs are products that use many parts of the bank including legal, trading, borrowing, lending and execution.

“The [European banks] have a swap desk that sells a swap to the fund,” said Deborah Fuhr, BlackRock’s global head of ETF research and implementation strategy, at the New York roundtable. “The swap desk can do securities lending, yield enhancement and synthetic shorts based on this inventory backing the swaps for the ETFs. So there’s a large potential revenue stream from this. And for many of them, this income stream was one of the real reasons to get into the ETF industry.”

For the rest of this story go to Markit Magazine.

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ETFs Cross $1 Trillion Milestone

Just another $10 trillion more to go.

The ETF industry crossed the $1 trillion in assets milestone for the first time yesterday. Actually, $1.027 trillion to be exact, according to BlackRock’s Global ETF Research and Implementation Strategy Team. It took 17 years for the industry, which includes all exchange-traded products classified as ETFs or ETPs, to achieve what took the mutual fund industry 40 years. The first ETF, the SPDR, launched Jan. 29, 1993, so just edged in under 18 years.

The modern mutual fund industry, which began with the Investment Company Act of 1940, crossed the $1 trillion mark in 1980. There are currently $11.51 trillion in assets under management in the U.S. mutual funds, according to the Investment Company Institute.

According to Blackrock, in the U.S., as of December 16, there were 894 ETFs with $887.2 billion in assets under management from 28 providers on two exchanges. Year to date, 171 new ETFs have been launched in the U.S., while 49 were delisted. Another 828 ETFs are in the regulatory pipeline. The $1 trillion comes when you add in the $115.5 billion from the 185 ETPs listed in the U.S. There are currently 20 providers and they all trade on one exchange. That’s ups from 142 ETPs with assets of $88.1 billion from 17 providers a year ago.

“Cost features make ETFs and ETPs among the most ‘democratic’ of investments, as a product’s pricing is consistent regardless of the type of investor or level of assets invested,” said Deborah Fuhr, the head of Blackrock’s ETF research team. She said the growth reflected the products expansion to retail investors. Providers are expanding into more specialized areas to cater to the growing number of professional and retail investors using ETFs as advanced portfolio construction tools. “The increasing availability of these highly-specialized ETFs and ETPs across the full spectrum of equities, fixed-income and alternative investments means that investors can use these vehicles to instantly deploy capital to take advantage of new investment opportunities – with complete transparency into the underlying investments as well as low cost.

Net new asset flows this year show increased interest in equities in both developed and emerging markets, compared to a drop off in net new asset flows among fixed income and commodities. Most striking was through November, net new flows into North American equity ETFs/ETPs jumped 950% to $21 billion, compared with just $2 billion in 2009. Over the same time period, flows into emerging markets equity ETFs/ETPs totaled $29 billion, up from $27 billion last year. Flows into fixed income products fell 30% to $31.2 billion, compared with $44.8 billion last year, while flows into commodity products plunged 65% to $11.4 billion from $32.6 billion a year ago. In November, ETF trading volume accounted for 24.1% of all United States equity turnover.

For more info check out Daisy Maxey’s piece in the Wall Street Journal and IndexUniverse.com.

Capital Link Gives Index IQ Top Awards

Index IQ won the top awards at Capital Link’s 9th Annual Closed-End Funds and Global ETFs Forum Wednesday in New York.

In the elite Metropolitan Club overlooking Central Park, about 900 people came to listen to industry insiders give their view of the industry today.

“Lack of clarity on what an ETF remains a big issue in the industry,” said Deborah Fuhr, BlackRock’s global head of ETF research and implementation strategy, who gave the conference’s State of the Industry address. She said calling all exchange-traded products ETFs creates confusion among investors and things need to be given specific names so that people know what they are buying. “There should be clarity. Classification is important for tax regulations, which can have an impact on the use of an ETF.”

Among the seven awards given out by Capital Link, Index IQ’s IQ Hedge Multi Strategy Tracker (QAI) won Most Innovative ETF in 2009. It’s tracking index, the firm’s IQ Hedge Multi Strategy Index, won Most Innovative Index. IShares took awards for Best Shareholder Relations and Best Investor Relations ETF Website. Michelle Fuller of State Street Global Advisors won the award for making the biggest contribution to the ETF sector in 2009. The award ceremony neglected to say exactly what her contribution was.

Morgan Stanley won the award for the Best Research Team for ETFs in 2009. Dominic Maister, the executive director of Morgan’s team, won the award for the analyst who made the best contribution to the ETF sector last year.

The Capital Link awards are chosen by a nominating committiee of 14 industry insiders and analysts.

Mazzilli to Leave Morgan Stanley

In an update of my previous post, Murray Coleman of IndexUniverse reports that Paul Mazzilli, Morgan Stanley’s top ETF analyst is expected to soon leave the firm, his home for the last 33 years. It’s unknown whether Mazzilli was downsized or decided to take a buyout, but the move comes just months after London-based Deborah Fuhr left Morgan. Together, Mazzilli and Fuhr were considered the top two ETF analysts on Wall Street. Fuhr recently joined Barclays Global Investors as global head of ETF research and implementation strategy.