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.
Felix Goltz, Head of Applied Research at Edhec-Risk Institute observes, “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 or even higher levels.
“This high level of satisfaction is 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.”
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, Edhec maintains that ETFs have become important to asset allocation strategies. In the survey, Edhec was 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.
Goltz says, “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. The results show that there is a dominance of broad market ETFs which is particularly pronounced in core portfolios. Goltz says, “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 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.”
As the ETF market is maturing and as these instruments are ever-more widely used, Edhec ponders the impact ETFs will 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.
Goltz concludes, “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.”