Growth of ETFs
ETFs have become more efficient tools for beta implementation as the market has grown. Global AUM ETF AUM grew 16% to $2.78trn in 20144, and BlackRock projects that the industry will add another $1 trillion in assets by 2017, resulting in even better liquidity and lower trading costs.
The cost of ETFs offering broad exposures is being reduced by competition and the increasing size of funds, which allows managers to spread fixed costs such as administration and custody fees among more units.
While ETFs were initially created to provide access to liquid equity indices representing the large capitalisation segment of well-established developed markets, the industry has expanded, with more than 5,7005 products available globally today.
A continuing trend
The past decade has seen an unprecedented level of growth in index investing.
We believe that this trend will continue, putting increased focus on instruments that offer efficient exposure to indices.
As financial markets grow and evolve the outcome of vehicle comparisons change. We urge investors to continuously monitor their full opportunity set beyond myths and pre-assumptions and select the solutions that are best for them at that specific time of trading.
For example, five years ago ETFs were at a much earlier stage of development, with less choice and liquidity than today, often resulting in higher trading and management costs compared to futures. As described above, that situation has changed dramatically to where ETFs are now more efficient than futures in many cases. The efficiency and breadth of offering of ETFs is likely to continue to grow.
A key factor to watch in the current trend of richness of futures will be cost of the balance sheet, which evolves as the banking business model adapts to market and economic conditions. While each bank will deploy capital differently, and have different financing costs, it appears rather unlikely that any of them will achieve the lower levels of cost of capital enjoyed before the 2007/2008 financial crisis.
Banking regulation will also evolve as the Basel framework and the Volcker Rule reach their full-implementation status. While it is difficult to speculate on their impact, we deem it unlikely that regulators will unwind these frameworks or materially change the direction undertaken.
Careful consideration
As for any financial instrument, beta vehicles evolve over time as markets and regulation change. The last 12 months have witnessed a significant change in market conditions, which should prompt investors to reconsider their long-held ideas and practices related to accessing beta.
Futures are experiencing headwinds driven by supply and demand dynamics and the increased cost of capital caused by regulatory changes. A persistent richness of the futures roll versus its fair value has been observed across several contracts over the last 12 to 15 months – particularly towards year-end. Large scale, liquid exposures that very commonly use futures such as the S&P 500 and the TOPIX have both recently seen hugely increased costs.
ETFs, meanwhile, have benefitted from tailwinds associated with increased volumes and larger AUM, producing continually lower costs over the past five years.
While ETFs and futures will continue to co-exist and serve investors well across different portfolio usages and applications, BlackRock expects ETFs to be the winner as they increasingly represent an efficient substitution opportunity for beta investors.
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