In 2008, the exchange-traded fund (ETF) industry experienced its first major fall in assets since the first ETF began trading in 1993. According to the Investment Company Institute (ICI), a national association representing U.S. investment companies, in November 2008, U.S. ETFs held combined assets of $478 billion, a significant drop from the November 2007 level of $572 billion.
In 2009, however, equity markets around the world recovered. Massive government spending designed to shore up the world economy took hold and liquidity flooded the marketplace. ETFs attracted a major slice of the growing pie, swelling to new heights by mid-year and climbing to well over $700 billion in combined assets by year-end (see “Call it a comeback").
The ICI reports that ETF assets increased $246 billion in 2009. That was a rise of 46.3% since December 2008. Domestic equity ETFs attracted a major chunk of those funds, increasing by $100 billion since December 2008. Global equity ETFs, which took the brunt of the cash exodus that occurred in 2008, recovered by $96 billion in 2009. As of the end of December 2009, bond funds held $107 billion and hybrid funds held $169 million (see “On the uptick”).
Futures’ ETF Guide includes all ETFs that traded more than 100,000 units a day, on average, during the last quarter of the previous year. Based on that period in 2009, 294 ETFs made the cut (out of more than 790 available at the end of the year). Based on 2008 numbers, 273 ETFs were included in the Guide.
However, while both assets under management and the number of available ETFs rose, volumes fell, in some areas significantly. In the 2010 guide — based on the numbers from the last quarter of 2009 — the average daily volume of all ETFs listed was 4.5 million units. In the 2009 guide, the average daily volume for the ETFs that made the 100,000 limit was 6.5 million.
ETFs, and the even the language used to describe them, continue to evolve.
One ETF sector that continues to shift with the times is commodities. Commodity-linked ETFs saw some significant moves, reflecting investor appetite for risk and reward in various markets. The last quarter of 2009, the most popular commodity-linked ETF was the United States Natural Gas (UNG) ETF, which was booking an average daily volume of nearly 30 million units a day. The previous year’s leader, the Energy Select Sector SPDR (XLE) ETF dropped to third on the list to under 19 million units a day. In 2008, XLE closed out the year with an average daily volume of 48 million units.
Some major shifts also occurred in international and emerging market ETFs. Although the top ETF in this sector, the iShares MSCI Emerging Markets Index (EEM) ETF, remained the same, it fell significantly in average daily volume, logging about 71 million units a day to close out 2009 vs. more than 127 million units a day in 2008. However, the iShares products continued to hold strong, claiming nine of the top 10 spots in this category. In 2009, as it was in 2008, only the Vanguard Emerging Markets Stock (VWO) ETF was able to break their hold, coming in seventh, trading 10 million units a day in 2009.
Still, the biggest issues in the ETF industry stayed the biggest, although with significant volume drops. The popular Standard & Poor’s Depository Receipts (SPDRs, pronounced “spiders,” which track the S&P 500) fell to just over 160 million units a day in 2009 vs. roughly 439 million the year before. The QQQQs (pronounced “Qs,” which track the Nasdaq 100) also experienced a drop, falling to 86 million units a day from about 227 million in 2008.
Bear market ETFs held firm in 2009, with leveraged ETFs doing the best. As 2008 came to a close, the UltraShort S&P 500 ProShares (SDS) ETF was trading nearly 60 million units a day. At the end of 2009, the Direxion Daily Financial Bear 3X Shares (FAZ) ETF was trading 65 million units a day. SDS slipped to the second spot with roughly 33 million units a day.
The popularity of the bear market sector also was reflected in the number of these products that made the 100,000 unit-per-day cutoff. The current ETF guide includes 36 of these products, while last year’s guide only included 25.
Among currency-linked ETFs, a major bright spot was the PowerShares DB U.S. Dollar Index Bullish (UUP) ETF. UUP closed out the year with an average daily volume of 5.8 million units due to the yearend rally in the dollar. For the same period in 2008, UUP booked about 917,000 trades a day.
Also in 2009, the era of actively managed ETFs officially began. After several false starts, the industry finally received regulatory clearance. However, one of the first viable products, from Bear Stearns, proved to be not so viable as it followed the company into oblivion. Others, however, were offered by PowerShares, Grail Advisors and BetaPro. While these products were not the instant success that many had hoped, despite the cost and liquidity advantages over mutual funds, they are slowly gaining traction and are a potential area of growth in 2010.
2010: RETAIL INVASION?
Despite receiving significant coverage in mainstream media, ETFs continue to be a fraction of the size of the overall mutual fund industry. For the ETF optimists, that means there remains a massive amount of upside for the products.
Deutsche Bank analysts Christos Constandinides and Shan Lan recently penned “Exchange Traded Products: 2009 Market Review & 2010 Outlook.” Expanding on that report in written responses to Futures, they concluded that “we are approaching a time when ETFs start to challenge mutual funds for assets in the average investor’s portfolio.”
One reason, they wrote, was that major new entrants such as Charles Schwab, PIMCO and Blackrock — likely to be followed by Goldman Sachs and T. Rowe Price — will re-write the rules of doing business in the ETF market. These heavyweights are likely to bring innovation, but perhaps more important are their distribution channels and customer base.
“The direct result of the increasing competition and the entrance of discount brokers is decreasing trading cost,” they wrote. “Charles Schwab’s decision to waive trading commissions for its ETFs signals that ETFs are going massively retail. Reduced trading cost makes ETFs attractive for average investors with small amounts to invest (dollar-cost-average). We expect this movement in the industry to cannibalize significant assets from the mutual fund industry.”
In 2009, ETFs reflected the massive shifts that changed the entire financial landscape. There were winners and losers, but in all the industry survived and by doing so perhaps recovered some of the luster that it lost during the global financial meltdown.
ETFs proved to be useful tools for all types of investors, who were hungry for flexibility and control during a period of significant turmoil. The products allowed traders to find opportunity in familiar areas and find exposure in new ones. The next challenge for ETFs will be to help carry a global economy toward a re-tooled future with a changing regulatory landscape and evolving investor tastes for both risk and reward.
James T. Holter works as technical editor and contributor at Futures.