We start off with a point of clarification: Over time, the term “Exchange-Traded Fund” (ETF) has tended to become a blanket term used in place of “Exchange-Traded Products ETP” (ETP). While all of the former are the latter, it’s not the case the other way around. All ETPs are financially-engineered products benchmarked to myriad asset classes: stocks, bonds, commodities, real estate, etc. When designed in plain vanilla fashion around a large “basket” of stocks, bonds or specific commodities, they’re considered ETFs. When the basket becomes smaller, adds special features such as leverage or short exposure, et al, they’re considered ETPs. Hereafter, both ETFs and ETPs will be referred to as “ETPs” while the terminology used in the sources will remain untouched.
Over the past year, there has been a boom in the ETP industry for a variety of reasons. The historically volatile market conditions in 2020 led to investors turning to the transparent structure and tradeability of the ETP structure to meet their liquidity concerns.
In 2020, ETP trading volumes in the U.S. showed very high correlations with the volatility index, as exemplified by a report presented by State Street Global Advisors:
Over the past ten years, there had been a 60% correlation of total ETP trading volumes to changes in the VIX. Across the entirety of 2020, the correlation between 10-day trading volumes and the VIX increased to 82%.
The deep pools of liquidity formed from high investments also enabled the availability of a strong secondary market for efficient transfer of risk. Nowhere was this more evident than in March of last year:
As illustrated in the chart above, there is a general trend that whenever ETP trading volumes spiked during 2020, overall flows often remained relatively muted. Over the year, ETP flows registered a record $505 billion in flows, with November registering the most inflows for any month ever ($90 billion) despite ranking sixth in monthly volumes.
2020 also cemented the importance of retail investors who accounted for higher trading volumes than all others except high-frequency traders.
Contrary to popular media hype during the GameStop imbroglio, not all investors were focused on “meme” stocks; as per Vanda Research, March 2021 ended with retail investors taking a keen interest in the rich ETP space over all other categories:
This rise in interest in the ETP space is, by means, restricted just to the U.S. As per the World Federation of Exchanges, value and volumes of trades within this space in 2020 were up 42.3% and 73.6%, respectively, relative to 2019. In terms of number of trades, the EMEA region saw the highest increase (334%), followed by APAC (187.6%), and then the Americas (47.3%). The Americas, of course, remained the largest market in terms of trading activity with a 70.6% share.
This suggests a fascinating aspect of trend transference when it comes to trading preference: the U.S./Americas leads the pack, with EMEA and APAC following close behind. While analysing European sentiment as a whole is a little more difficult – given the wide distribution of countries – some extrapolations can be made to support this idea. Statista estimates that popular online Dutch broker DeGiro – with a presence in 18 European countries – has registered a nearly 408% increase in online accounts from 2017 to the first half of 2020.
In 2021, ETP trends seen in 2020 seem to be holding course – and in fact, strengthening. By May 2021, over half a trillion dollars in flow went to global equity funds.
Around $388 billion of the $495 billion total is attributable to ETPs. Of that $388 billion, around $210 billion went to U.S. equity ETPs.
In one of May’s instalments of J.P. Morgan’s popular “Flows & Liquidity” series, Managing Director Nikolaos Panigirtzoglou asserted, “ETF flow has represented a wall of money backstopping each dip in equity markets so far this year” further illustrating the correlation with the chart below:
He went on to remark that this behaviour is driven by “mostly retail investors.”
This behaviour is perhaps unsurprising: retail investors “buying the dip” via ETPs is an efficient means of deploying a highly-liquid, risk- and cost-efficient investment strategy protected by the transparent and centralized framework of the exchanges.
An ETP seems to bring to many a mind a “passive investment vehicle”, i.e. an instrument underlying an index with only periodic rebalancing and reconstitution. This is not quite true: With the rules changes by the SEC last year allowed for actively-managed ETFs (also known as “semi-transparent ETFs”), an increasing number of firms are moving into the ETP space by either converting mutual funds into ETPs as well as adding their own variations. The rule change allows active fund managers to maintain their proprietary formulas, protect their research and change up their holdings as often as necessary. Actively-managed exchange-traded vehicles also get to offer the tax advantages offered to passive exchange-traded instruments.
A powerful example of this new type of investment vehicle would be the Cathie Woods-led Ark series. The company’s Ark Innovation ETF (ARKK) is currently quoted at around the $120 level with a 5-year annualized return of over 40% while pursuing investments in companies poised to bring disruptive innovation.
Given high inflation in the U.S., real estate investments have been peaking in recent times. As per the Center for Financial Research and Analysis (CFRA), there were 35 equity REIT exchange-traded vehicles managing a total of about $87 billion in assets as of August. A few companies – including Janus Henderson, Fidelity Investments, SS&C ALPS Advisors and Invesco – have launched actively-managed REIT exchange-traded vehicles this year, thus increasing the number of avenues for retail investors to generate above-average returns.
For any asset manager, the time to go the ETP way is right now. With the continuing blossoming of the retail investor class and the explosion of outreach through online channels and media, the paradigm shift is investor segments and outreach is nearly complete. According to CFRA Research, there were around 200 new ETP launches in the first half of 2021 alone. On average, there used to be around 300 new launches each year.
In recognition of the need to nurture this space, Nasdaq’s Designated Liquidity Provider program is now giving market makers new incentives to provide liquidity in emergent ETFs. It is only a matter of time before such incentives are strengthened in EMEA and APAC.
FlexFunds is uniquely positioned to provide asset management firms with turnkey or custom-built solutions that facilitate the setup and launch of ETPs, fund accounting, and corporate administration services. With over $1.5 billion under management and more than 250 issuances in over 30 countries, FlexFunds has supported financial institutions, hedge funds, investment advisors, fund managers, and real estate investment managers to enhance the distribution of their investment strategies, facilitating access to global investors. If you would like to learn more about our services, we invite you to arrange a personalized session with our financial experts to get started in the ETP space. Don’t hesitate to get in touch with us at www.flexfunds.com
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1. Independent entities.FlexFunds ETP and FlexFunds Ltd. are not managers of the special purpose vehicles, collectively, responsible for the issuance of Notes under the Global Note Programs.
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