What if I told you that today’s US exchange traded product (ETP) landscape is dominated by large, diversified exchange traded funds that seek to track an index? That statement should sound obvious, but it doesn’t line up with the headlines that seem to dominate ETF coverage of late. But sometimes, it’s good to step back and look at the facts to keep things in perspective.
It is often the more complex ETPs — those funds that might be better suited for institutions or trading professionals than buy-and-hold investors — that grab the attention of the media. It is also true that in recent years, the ETF Industry has introduced more complex ETFs, such as leveraged and inverse funds, or products that are backed principally by derivatives rather than physical holdings. These niche products have caused the media to question the suitability of ETFs for long-term or individual investors as the Wall Street Journal did in its recent piece, “Is It Time to Limit Access to Leveraged Exchange Traded Investments?”
iShares has been vocal about advocating a classification system that clearly defines the differences between exchange traded products, an umbrella term that is currently used to categorize a group of funds which can vary greatly in their goals and structure. We think a system (ideally through nomenclature but also through “speedbumps” at time of purchase like additional paperwork) that helps to ensure that investors clearly understand what it is that they are buying is critical for the ETF Industry.
But beyond the headlines and discussions over a classification system, the fact remains that the vast majority of ETPs being used by investors today are traditional, market capitalization weighted ETFs that are designed track an index, like the Russell 2000 Index.
Like mutual funds, the vast majority of ETFs are structured as 1940 Act investment companies. ETFs are securities subject to market risk (the risk that an investment will go up or down). They are collateralized by an underlying portfolio of securities. The 40 Act limits the use of derivatives and prohibits affiliated transactions (i.e. a bank cannot serve as both a sponsor and a swap counterparty).
What do I mean when I say “vast majority”? Let’s look at US data from iShares and Bloomberg as of the end of the first quarter:
- The US ETP industry had $1.2 trillion in assets under management.
- The 100 largest US ETPs accounted for 80% of those assets under management.
- Of the 100 largest ETPs, 90 were ETFs that are governed by the 40 Act — the same act that governs mutual funds.
- Of the largest 100 ETPs, only 1 is an inverse/leveraged fund.
- All but 6 of the 100 largest funds hold physical securities.
- Of the top 100 funds, the average number of holdings in each one is 450 names.
At the end of the day these numbers show that it’s the big broad diversified funds that attract the bulk of the assets. Niche ETPs are exactly that — niche funds that are designed for a smaller segment of the marketplace and that might fulfill a particular investment need. These funds are not for everyone; as with any investment vehicle, it makes sense to talk to your financial advisor or ETF provider before making any purchasing decision.