ETF Guide: A rising tide

Click here for Futures' 2011 ETF Guide.

In 2009, the exchange-traded fund (ETF) industry recovered from its first significant contraction since its birth in 1993. As the stock market rallied, dollars poured into ETFs and by the end of the year the industry boasted more than $700 billion in assets, according to the Investment Company Institute (ICI), a national association that represents U.S. investment companies.

However, that growth was selective. While assets under management and the number of ETFs offered by the investment community rose in 2009, volumes fell. Indeed, the average daily volume of the ETFs in Futures’ 2010 ETF Guide was nearly 2 million units less than the year before. Although funds were flowing, activity was slowing. In addition, although investors returned to all asset classes that year, bond ETFs more than doubled to $107 million while domestic equities grew by less than a third.

In 2010, asset growth not only continued, it did so broadly. Nearly all sectors surged by healthy rates, while the drop in average daily volume for the funds that are included in Futures’ 2011 ETF Guide leveled off. And that growth was steady, powering higher throughout the year (see "High-octane recovery," below).

The ICI reports that ETF assets increased to $927.62 billion by November 2010, a rise of $189.70 billion or 25.7% over November 2009. Domestic equity ETFs attracted a large part of those funds, increasing by $96.19 billion since November 2009. International market ETFs, which along with bond ETFs also recovered strongly in 2009, attracted an additional $56.66 billion in 2010. At the end of November 2010, bond funds held $140.97 billion and hybrid funds held $312 million (see "Across the board," right).

Futures’ ETF Guide includes all ETFs that traded more than 100,000 units a day, on average, the last quarter of the previous year. Based on that period in 2010, 342 ETFs made the cut (out of 920 available at the end of the year). In 2009, 294 ETFs were included in the Guide. With ETF activity spread out across an increasingly broader base, however, the average daily volume of all the ETFs in the Guide continued to thin out, sliding about another 1 million units a day in 2010.

2011: Speculative growth?

One of the biggest stories in trading the last year has been the evolving regulatory framework. Lawmakers have responded to the 2008 financial crisis with a list of new laws and expectations for regulators. While OTC derivatives and more complex institutional products have received the most attention, retail products, such as ETFs, are not immune to scrutiny.

The regulations most likely to affect the ETF market are position limits. The Dodd-Frank financial reform legislation required the Commodity Futures Trading Commission (CFTC) to have energy and metals market position limits in place by January — a deadline missed. However, on Jan. 13, the CFTC did vote to open the position limit proposal to public comment.

How the regulations will impact the retail ETF market is unclear. Major players, such as Blackrock, which operates the iShares ETFs, have vigorously lobbied against restrictive limits.

Leveraged ETFs are another area that has drawn regulatory attention. Indeed, in early 2010, the Securities and Exchange Commission restricted the listing of new leveraged ETF products. As is obvious from the funds flowing into these products, however, investors aren’t ready to turn their back on leveraged ETFs just yet.

Accessibility is an ETF trend that is likely to continue. TD Ameritrade is the latest retail securities broker to offer commission-free ETF trading. It joins Charles Schwab, Fidelity and Vanguard as major retail players to waive commissions for some ETFs.

Despite massive changes to the regulatory framework in the United States, ETFs continue to persevere and have demonstrated value as a vehicle for both active speculation and passive investment. As the pieces fall into place, ETFs will be poised to take full advantage of a more-certain regulatory future.

What’s next with ETFs
By Daniel P. Collins

A few years ago when we spoke with Ivers Riley, the founder of the exchange-traded fund, he told us that the original concept for ETFs was a broad one encompassing multiple asset classes and products.

While initially the success of ETFs came from products on popular broad based indexes, each year has brought the product closer to that broader vision. In recent years we have seen the emergence of commodity-based ETFs, leveraged ETFs, bear market ETFs, currency ETFs and actively managed ETFs. Most recently that has extended to volatility and managed futures products.

In January ProShares entered the fray of volatility-based Exchange Traded Notes (ETNs), announcing the launch of two ETNs based on the Chicago Board Options Exchange Volatility Index (VIX) joining Barclays, Citigroup, UBS and VelocityShares with VIX-based ETNs.

Wisdom Tree Financial in January launched a managed futures ETF (WDTI), joining iShares, who launched its Diversified Alternatives Trust in 2009. Wisdom Tree’s ETF is a long/short ruled-based strategy that incorporates 24 exchange-traded futures following the DTI Index. Auspice Capital Advisors plans to launch an ETF in the first quarter that will follow its Managed Futures Total Return Index.

Offering retail access to managed futures has been extremely cumbersome because of the regulatory regime for commodity pools, which has led to the proliferation of managed futures mutual funds and now managed futures ETFs. Existing commodity trading advisors can offer their programs to retail investors more easily through one of these structures than the traditional commodity pool route. Auspice President Tim Pickering says managed futures ETFs will be more difficult because ETFs have to be based on a transparent benchmark. "You have to show the strategy," Pickering says.