Net new inflows for leveraged, inverse and leveraged inverse exchange-traded products totaled $2.1 billion in June alone, according to the latest figures available. In the first six months of 2011, investors put $6.1 billion in new assets into ETPs — almost as much as the $6.4 billion for all of 2010, according to BlackRock Inc's “ETF Landscape Industry Highlights” published in July.
“What we're seeing now is an evolution of the (ETP) industry,” said Scott Burns, director of ETF research at Morningstar Inc., Chicago. “A lot of people think ETFs are primarily used by retail investors. That is increasingly not the case; they're tools for pension managers when building strategies, for tweaking risks inside of the investment portfolios.”
The group of exchange-traded products that includes leveraged, inverse and volatility-trading instruments is a relatively new breed, specifically designed to appeal to institutions. “They're much more tools for trading or hedging, rather than buy-and-hold securities,” said Edward McRedmond, senior vice president and head of institutional and portfolio strategies at Invesco PowerShares Capital Management LLC, Chicago. PowerShares markets leveraged ETPs through a partnership with Deutsche Bank AG.
Worldwide, $49.9 billion was invested in leveraged and inverse ETPs as of June 30 — a hefty sum considering they were first introduced in the U.S. only five years ago. Overall, a total of 577 leveraged, inverse and leveraged inverse ETPs trade on stock exchanges globally, according to BlackRock data as of June 30. Such ETPs account for about 3.5% of total ETP assets, but they claim 11% of the trading volume — evidence that these securities are primarily used to gain short-term exposures.
Also dubbed “geared” ETPs, leveraged and inverse products aim to deliver usually two or three times the return of the correlating asset or the inverse of a particular index in a trading day, respectively. There are also ETPs that aim to do both. The ways they are constructed vary widely, but it's often done using assets and derivatives in order to mimic the stated return objectives, sources said.
One of the newest types of ETPs used by institutions to control volatility within investment portfolios is based on short-term and medium-term futures contracts on the Chicago Board Options Exchange Volatility Index, or VIX — often referred to as the “fear index.” First introduced in 2009, these securities already garnered a total of $2.3 billion in assets as of June 30. On Aug. 4 alone, the VIX jumped 35.41% and $3 billion in VIX ETPs were traded in the biggest volume day for the securities.
“Large institutional investors are rethinking their portfolios, and (leveraged and inverse ETPs) allow them flexibility to manage exposures,” said Mr. Koesterich of iShares, which does not offer leveraged and inverse ETPs. However, its parent company BlackRock. does distribute iPath products, that include geared ETPs sponsored by London-based Barclays Bank PLC.
“What the (ETP) industry is doing is looking at what institutional investors are investing in today and going to the product development laboratory to come up with a formula to deliver that asset class or strategy” through an ETP, said Michael L. Sapir, chairman and CEO of ProShares Advisors LLC based in Bethesda, Md. The firm is the largest provider of geared ETFs with about $26 billion in assets under management.