Sunday 19 September 2010

FT Alphaville � Can an ETF collapse?

Like many innovations in finance that emerge from nowhere to explode in popularity with unknown consequences, exchange-traded funds (ETFs) have gone from obscurity when they were first invented in 1993 to making up more than half of all the daily trading volume on American stock exchanges today. They also made up 70% of all the canceled trades during the Flash Crash on May 6, despite representing just 11% of listed securities in the United States, suggesting that ETFs remain poorly understood by both investors and regulators.

The extraordinary popularity of exchange-traded funds, open-ended mutual funds that trade like stocks on an exchange, is undeniable. However, the source of this popularity would seem to have two very different origins. ETFs are bought by many retail and institutional investors looking for low cost and highly liquid vehicles with which to buy whole indices in a single trade, and ETFs serve that noble function well. But, they are also extremely popular with and widely used by hedge funds and other traders looking for a simple way to mitigate broad-market risks, or neutralize beta, with a single trade. The appeal to a hedge fund manager of being able to short an entire market index or a whole sector with one transaction, instead of say 500 separate stock shorts to span the S&P 500 Index, makes ETFs very widely used as hedging vehicles by short-sellers. It increasingly looks like many new ETFs are now being designed for the purpose of marketing them to short-sellers.

These seemingly opposite interests in ETFs make for a large and lucrative market not just for the ETF operators like BlackRock’s iShares and State Street Global Advisors SPDRs, but also for the authorized participants–institutions that can create or redeem large blocks of new shares in an ETF (called creation units) for sale, and countless brokers that profit by trading ETF shares.

No comments:

Post a Comment