Over the past several years, institutional demand for ETFs has increased dramatically. Growth has accelerated after the 2008 financial crisis at a rate of 17% and institutional investors now hold more than 50% of U.S. ETF shares. With more than 1,500 ETFs currently, there is more liquidity in the market than ever, which is one reason for their popularity. While they represent one-third of all U.S. equity trading volume on any given day, ETFs still represent only about 10% of the U.S. mutual fund sector overall.
The ETF value proposition is significant and includes a wide range of exposures, intraday liquidity, full transparency and low cost across the board. Put to work for a number of uses, they are gaining share from traditional actively managed mutual funds and hedging mechanisms. Unlike many financial instruments that require operating management, ETFs let portfolio managers fine-tune portfolio exposures to mitigate risk, including equity, credit, and rate risks, and to take advantage of various investment styles. As ETF liquidities grow, they have become more attractive as alternative indices built for one type of solution are applied to others. Lackluster performance of active managers over the last several years has been a factor as well, in an environment of low interest rates and high correlation among asset classes.
Future growth will be driven by ETFs that provide exposure to nontraditional asset classes and geographic regions. New smart beta indices are being constructed based on various factors, such as dividend yields, stock-price volatility levels and equity quality ratings. ETFs designed to hedge risks are becoming viable alternatives to swaps, futures and other instruments. Additionally, ETFs provide unprecedented opportunities for effective cash management strategies. We interviewed three prominent people in the ETF space: two purveyors of funds and an index provider to discuss these and other trends in the market.