EDHEC-Risk Institutional investors’ views on exchange-traded funds
Felix Goltz, Head of Applied Research, EDHEC-Risk Institute and Director of Research & Development, EDHEC-Risk Indices & Benchmarks
Lin Tang, Research Assistant, EDHEC-Risk Institute
In the recent EDHEC-Risk European ETF Survey 2010, EDHEC-Risk Institute - with the support of Amundi ETF - collected and analysed 192 responses from European investment professionals on their use and perceptions on ETFs and competing indexing instruments. The survey results reveal an increasing maturity of the ETF market. Despite this increasing maturity, the respondents' views indicate that ETF products still have ample room for further development.
Use of and satisfaction with ETFs
Figure 1 summarises the use of ETFs and the satisfaction rates with ETFs among our respondents for various asset classes. In addition to the current survey's results for 2010, we show the results of our earlier surveys for comparison.
The number of ETF users refers to the percentage of respondents who use ETFs in a given asset class in which they invest. Our results show that this percentage is starting to level off. There are some notable increases in usage, such as ETFs for fixed-income products (from 61% to 68% for government bond ETFs and from 55% to 60% for corporate bond ETFs over the last year) and hedge fund ETFs (which increase from 34% to 38%). However, on the whole, increases in the number of users are much less pronounced than in past years. Another aspect of use is the intensity of use in terms of assets invested in ETFs as a percentage of overall assets invested in a given asset class. The intensity of usage has grown significantly over the past year. For the respondents who do invest in the particular asset class, figure 1 shows the share of their portfolios accounted for by ETFs. Other than equity ETFs, whose share has fallen, ETFs have gained a significant share of assets over the past 12 months. Hedge fund ETFs now account for one-fifth of the hedge fund investments of the respondents who use ETFs for this particular asset class.
It is interesting to note that the high and increasing usage of ETFs comes against a backdrop of equally high satisfaction levels. Even for asset classes where ETF satisfaction had dropped during the 2008 liquidity crisis - such as corporate bond and hedge fund ETFs - the satisfaction levels have reverted to the pre-crisis level or even higher levels.
These high degrees of satisfaction are consistent with survey respondents' views of ETFs, views often more favourable than those for competing indexing vehicles. In fact, when it comes to comparing ETFs, futures, total return swaps, and traditional index funds, our survey confirms that ETFs, along with futures, are the preferred indexing vehicles.
We compare the respondents' views on different indexing instruments for 10 different quality criteria in figure 2 to see the advantages and disadvantages of each instrument. The numbers in the exhibit indicate the average ratings received by each instrument on a scale of one (poor) to three (very good). Overall, ETFs and futures receive the highest scores, while total return swaps receive the lowest. ETFs are rated outstanding for ease of use (minimum subscription and operational constraints) and range of products. ETFs also outscore traditional index funds on all 10 criteria; overall, index funds have a score of 2.15, as compared to 2.37 for ETFs. These ratings suggest that total return swaps (TRSs) are particularly poor in the sense that they are less liquid, costlier, and harder to use than the three other products.
ETFs in the investment process
Given the perceived benefits in terms of liquidity, cost efficiency, and product variety, ETFs have become important to asset allocation strategies. In our survey, we are able to recover information not only on satisfaction and usage, but also on the ways in which ETFs are used and how they fit into the overall asset allocation of respondents.
ETFs stand out for a number of more advanced features, such as securities lending, trading options on ETFs, short selling ETFs and inverse/leveraged ETFs. In our survey, we find that the use of inverse and leveraged ETFs is now relatively common and these product innovations are now firmly established. The greater popularity of inverse and leveraged ETFs may be the result of their operational simplicity. Inverse and leveraged ETFs are pre-packaged margin products. It is not necessary for investors to manage the margin account on their own as they must when they short ETFs by themselves. Though they are still far from mainstream instruments, options on ETFs have progressed somewhat over the years, as they are now used by 8% of investors, up from 6% in 2009. In contrast, securities lending, trading options on ETFs, and short selling ETFs, are used by only a small fraction of respondents (less than 15%). This may be due to the obstacles raised by the recent criticism of short selling in general.
When asking investors how they use ETFs in their overall investment process, the results show that investment in ETFs is associated mainly with long-term exposure to broad market indices. All the same, that up to 50% of respondents frequently use ETFs for short-term exposure to specific market sub-segments and for tactical bets indicates that other investment purposes are increasingly important as well.
Given the large variety of indices tracked by ETFs, an interesting point is to see which types of ETFs are used in different areas of portfolio management. Figure 3 summarises the use of different ETFs in the core-satellite allocation. The results show that there is a dominance of broad market ETFs which is particularly pronounced in core portfolios. Although ETFs on narrower segments of the respective markets are used relatively often as satellite vehicles, the dominance of broad market ETFs in the core is clear. This dominance is not limited to equities, as these ETFs also account for the bulk of the demand for government bond ETFs and corporate bond ETFs, though to a somewhat lesser degree. On the whole, perhaps the most telling information from Figure 3 is that, instead of actively managing their long-term beta exposure to obtain the most efficient risk/return trade-off in their core portfolios, European investment managers focus on using broad market indices.
An increasingly mature market with room for improvement
As the ETF market is maturing and as these instruments are ever-more widely used, one naturally wonders what impact ETFs make on the broader markets. The survey finds that many respondents have themselves observed that ETFs have improved the price efficiency of the spot and future markets. Moreover, many respondents have observed increased liquidity in the underlying market after the introduction of an ETF. Many practitioners, then, seem to share the views of academic studies - that is, that the liquidity of underlying markets and the price efficiency of the futures market improve significantly after the introduction of ETFs. In addition, we find that about half of respondents frequently monitor information on ETFs rather than on the underlying markets. This finding suggests that practitioners exploit relationships between ETFs and underlying markets. Thus, in accordance with their increased use, it seems that ETFs have entered a phase in which they actually have an impact on their underlying baskets of securities and on related futures markets. About half of respondents frequently monitor information on ETFs rather than on the underlying market. In other words, practitioners rely heavily on the price leadership of ETFs and thus exploit ETFs not just as investment vehicles but also as sources of information.
Our survey results suggest that, despite the hundreds of ETFs already made available to investors in Europe, there is considerable room for new product development. Figure 4 shows that, on the whole, investment management professionals are requesting access to non-standard beta (emerging markets and alternative asset classes) or to traditional equity beta through new weighting schemes. On the other hand, investment managers are far less interested in ETFs that select securities either through ethical screening or through active stock-picking by a manager.
Overall, the significant impact that ETFs now have even on related and underlying markets, as well as the high rates at which they are used, shows that the ETF market has attained a considerable degree of maturity. At the same time, patterns of use and survey responses suggest that there is considerable room for further development of ETF products and for new ways of using them. In future surveys, we intend to keep monitoring how products and usage of ETFs in Europe will evolve.