From the March 01, 2010 issue of Futures Magazine • Subscribe!

ETFs roar into new decade

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.

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