July-August 2014

EDHEC RESEARCH: ETFs v futures: the race is on

CyclistsIn the second of two articles on ETFs, Felix Goltz of Edhec finds where ETFs are considered more advantageous over futures, and where they are not.

As part of the Edhec European ETF Survey 2013, produced by Edhec-Risk Institute with the support of Amundi ETF & Indexing, we asked survey respondents whether they invest in alternatives to ETFs, such as futures, total return swaps, and index funds and asked them to rate ETFs and their alternatives according to various criteria.

The responses are shown in the table and allow for a few general conclusions. First, in terms of liquidity, transparency, and cost, ETFs are considered advantageous although on some criteria they are less well regarded than futures. 

Second, ETFs are ranked highest for available range of indices and asset classes. Therefore, European investors and asset managers seem to be well aware of the growth in the diversity of ETFs in recent years. Third, futures are the most serious alternative to ETFs, but ETFs are perceived as superior with regard to minimum subscription, and operational constraints. They score highly for  tax and regulatory regime, too.

Therefore, it appears that implementation concerns with futures (such applying exact allocations even for small-sized portfolios) give ETFs an advantage. 

Fourth, the respondents believe that ETFs generally perform much better than total return swaps (TRS). Overall, we find that ETFs and futures receive the highest scores among the four products (2.38 and 2.43, respectively), while total return swaps receive the lowest score of 1.86. For individual criteria, ETFs are rated as outstanding in terms of ease of use product range, minimum subscription and operational constraints.

Interestingly, when we examine respondents’ answers with regard to their future use of each of the above indexation vehicles, we see that the results are broadly reflective of the quality scores assigned to the indexation vehicles by respondents. 

Hence investors’ detailed analysis of each indexation vehicle is in line with their predictions of future use. For instance, our research shows us that most respondents (60%) are planning to increase their investments in ETFs, while only 5% of investors plan a decrease. 

Similarly, we can now see that 26% of respondents are planning to increase their use of futures, compared to just 7% who are planning to decrease their usage of the product. 

However, the situation is much more balanced for index funds, which are in third place in terms of an overall quality score, with approximately the same number of investors planning an increase as there are planning a decrease (18 % and 15% respectively).

For TRS, which came in last in terms of an overall quality score, we can see that the outlook in terms of future usage is much more negative with only 11% of investors planning an increase in usage compared to 18% of investors planning a decrease. Thus in comparison to other indexation vehicles, we can see that ETFs have the brightest future in terms of usage.

Finally, we compared the investors’ expected usage of these products over time. The results suggest that despite the past growth and increasing maturity of the ETF market, ETF investors are still looking to increase or at least to maintain their use of ETFs and have a more favourable outlook of their use of ETFs than of their use of alternative indexing products.

In terms of demand for product types for product development in 2013, we found that the area of most interest to respondents is the emerging markets equities segment, with 42% of respondents wanting to see further product development in this asset class. Emerging equity ETFs have been on the top of the investors’ wish list for many of our past surveys suggesting that there is ample room for product innovation in this area.

This persistent finding may be explained by the fact that emerging equity ETFs are still mainly based on broad global, regional or country emerging market indices with relatively little choice available to obtain specific sector or style exposures within the emerging market equity universe.

We can also see that there is now an increasing interest among investors for development of ETFs based on alternative forms of indices, with 39% of investors interested in further development in ETFs based on smart beta indices. This percentage is slightly higher than the percentage in 2012 (37%). 

This result is interesting as there has been a considerable amount of product launches in the area of smart beta ETFs. 

The fact that investors see room for further product development despite the numerous product launches may be explained by the fact that product launches have focused on relatively few popular strategies representing a small number of risk premia, such as the value premium and defensive equity strategies. 

Given the increasing discussion on harnessing multiple factor premia from equity investing, including factors such as momentum, size, quality among others, it is perhaps not surprising that investors see room for further product development. Indeed, ETFs based on style indices or factor indices (with 34% and 31% respectively) are also among the most widely requested categories for future product development.

Felix Goltz is head of applied research at the Edhec-Risk Institute

EDHEC table

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