Insert your preferred cliche about markets and voting here, but exchange-traded funds reached the age of maturity this year in their ability to participate in the democratic process.
From Brexit to the U.S. election, traders and investors alike turned to single-country ETFs to express their views on how campaign rhetoric might translate into policy.
And institutional global-macro investors, who have long used ETFs to implement their strategies, are glad the other investors came along (while still asking, “Hey, what took you guys so long?”) But, for those looking to divine a directional leaning from asset flows or trading activity, the ETF ecosystem has again delivered its standard disclaimer to the arrivistes: Things are not always as they seem.
Consider the $1.7 billion iShares MSCI Mexico Capped ETF.
This 20-year-old product saw average daily trading volume surge in late October and sustain through Nov. 18. Other attributes of a healthier, multidirectional institutional ETF market also showed up, including greater short interest, a huge increase in open option interest and a 49% jump in assets.
Bloomberg ETF analyst Eric Balchunas identifies this surge as “create-to-lend” activity, whereby ETF market makers or institutional traders create shares of a product in order to meet short-seller demand.
According to Martin Small, BlackRock Inc.'s head of U.S. iShares, the $1.9 billion iShares MSCI United Kingdom ETF saw a similar spike in activity across the board in the days and weeks surrounding the June 23 Brexit vote.
While only recent examples, the two highlight the speed with which more dormant exchange-traded products can snap to life in an acute circumstance as more investors get comfortable with the utility and flexibility of ETFs, and understand the expanded ecosystem to include derivatives, arbitrage, securities lending and the creation/redemption mechanism.
While politics is just one input in the development of global-macro market views, a shifting interest rate environment and related currency fluctuations also have added to the depth of the ETF market.
Take the WisdomTree Japan Hedged Equity Fund, an investor favorite in 2013 and 2014 as quantitative easing took hold in Japan. The fund has experienced a net $5.9 billion in outflows this year through Nov. 17, according to FactSet Research at ETF.com, but the past few weeks have seen renewed interest in the ETF as Japan commits to economic stimulus and U.S. interest rates back up, said Jeremy Schwartz, director of research for WisdomTree Investments Inc., in New York.
Collectively, single-country (non-US) equity ETFs held $78.6 billion in assets as of Nov. 17, according to Bloomberg. This is a far cry from the assets held in broad-based regional developed and emerging market index ETFs, such as the $57 billion iShares MSCI EAFE ETF or the $42 billion Vanguard FTSE Emerging Market ETF.
The utility of single-country funds is often more fully realized on a relative basis (as opposed to targeted directional bets) by global-macro investment managers who reshape country exposures to trump the MSCI All Country World ex-U.S. index.
“Research has shown that alpha in international investing is derived from macro factors, particularly the country factor and especially in the case of emerging markets where the currency plays a large role,” said Carlos Asilis, Miami-based chief investment officer and co-founder of Glovista Investments LLC. “Over the last few years, global macro investing has been challenged and dispersion has been low due to non-traditional policy stimulus around the globe. But the U.S. reducing quantitative easing in late 2014 began the reversal of that trend.”
Some countries — particularly those with more closed and less liquid markets such as China and India — are underrepresented in investible indexes relative to their size while index firms such as MSCI and FTSE Russell monitor markets for their maturity and capacity to accept indexed assets.
“The growth in the breadth of the ETF market, as well as increased liquidity for existing products, has been a welcome development. Spreads are much tighter than trading ordinary shares on the local market, not to mention the cost of currency translation and custody,” said Mr. Asilis of Glovista, which manages about $1 billion for institutions.
David Garff, president and chief investment officer at Accuvest Global Advisors in Walnut Creek, Calif., assesses individual countries based on fundamentals, momentum, risk — which includes currency/rate differentials, and relative valuation. Accuvest manages nearly $400 million using 34 country funds and benchmarks to the MSCI ACWI ex-US for international portfolios.
“We respect the benchmark,” he said. “We do not think in terms of being over/underweight regions, or even emerging vs. developed. Everything is done at a country level.”