What’s Pushing the Volume in ETFs?

While active investors have witnessed a dramatic decrease in equity volume recently, the exact opposite is happening with ETFs. There has been dramatic growth in both the volume and number of ETFs available over the last several years. Current estimates indicate there are over a trillion dollars of assets invested in the 1000 plus ETFs in the US markets. A renewal of institutional interest is what is pushing up the volume in ETFs.

These instruments began in 1993 with a clear institutional bias, then interest migrated to the retail side as individual investors discovered the benefits of ETFs. Financial advisors started using ETFs regularly in 1998, beginning with the granddaddy of all ETFs the QQQ, then the SPDR and moving on to the new iShare families. What many investors have started to realize in these post credit crisis years is that collateralization is critical. What this means is most ETF’s fit under the 1940 Investment Company Act, meaning they are collateralized obligations. Therefore, institutions and other large investors have moved en masse back into the ETF space. In fact, reviewing the holdings of the 10 largest US endowments, eight out of the 10 use exchange traded funds in their portfolios. Other institutions are also becoming more comfortable with ETFs. Volume builds on itself as institutions see the greater and greater volume and interest, thus attracting more interest. At one time it was futures and other derivatives that attracted the most institutional interest. Presently, this interest has been swinging toward the ETF space in unprecedented volume.

Now that we know that the sharp increase in ETF volume is due to institutions getting back into the game, what exactly are these institutions using ETFs for? According to a study by Greenwich Associates and sponsored by BlackRock, 60% of asset managers use ETFs as a tactical rather than passive investment tool. Liz Tennican of Black Rock explained to Trader’s Magazine, “Most institutions use ETFs for cash equalization, manager transitions, rebalancing and making tactical adjustments to portfolios, according to the Greenwich study. However, the survey found a growing number of institutions are also using ETFs for liquidity management. ETFs can be a cost-effective way for institutional investors to capture beta exposure, while still maintaining the liquidity they need to meet redemption and contribution requests.”

The study indicates that nearly 50% of the interviewed asset managers plan on increasing their use of ETFs over the next 2 years. Even more importantly, not one gave the hint that he/she plans to cut back their use of ETFs. It looks like these tools are here to stay!

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