OK, technically, JPMorgan’s annual ETF extravaganza was really revealed late final month. Lots can occur in a month, similar to one of many authors sadly departing the financial institution since publication.
However the 1/4 of Alphaville that cares concerning the topic was on guide go away on the time, and there’s loads of good things to chew on within the 20th edition of the annual snapshot of the ETF industry.
The headline is that the worldwide ETF trade’s belongings have grown by ca $3tn because the final report, because of ongoing large inflows and rising markets. That’s greater than the entire market cap of the FTSE 100, or about one Nvidia lately.
Most of all although, the report highlights how ETFs have gotten a much more various and sophisticated ecosystem. That’s notably true within the US, the place a 2019 ETF rule has triggered a wild bout of spaghetti-flinging financial masturbation innovation.
Whereas most cash continues to circulate into traditional, vanilla passive funds, the proliferation of thematic ETFs, issue ETFs, multi-asset ETFs, lively ETFs and derivatives-based ETFs is accelerating. As JPM’s Marko Kolanovic and Bram Kaplan write:
. . . For the fourth consecutive yr, a majority of latest ETFs are actively managed. Moreover, managed threat/outlined end result, issue, name/put writing, and thematic funds remained vital areas of focus for issuers over the previous yr, collectively accounting for practically half of all new ETF launches. Cryptocurrency ETFs have been one other main space of focus over the previous yr; they accounted for ~5% of latest fund launches, and attracted over 40% of the AUM in newly launched funds over the previous yr.
Lively ETFs
The expansion of actively managed ETFs has been notably sturdy, as extra asset managers use the wrapper for new funds, changing previous funds, or as a share class of existing funds.
JPMorgan estimates that actively managed ETFs have accounted for over 60 per cent of all US ETF launches yearly since 2020. Their belongings have grown by about 70 per cent over the previous yr to succeed in ca $670bn. Certainly, over the previous yr they accounted for 1 / 4 of all US ETF inflows.
As JPMorgan factors out, this isn’t actually denting the broader transfer into passive funding methods — whether or not in mutual fund or ETF wrappers. Slightly, lively ETFs are merely nibbling on the market share of the mutual fund construction.
Apparently, there appears to be little curiosity in much less clear ETF constructions, which many thought can be finest for lively managers that didn’t wish to broadcast their trades in near-realtime.
Adoption of the non- and semi-transparent constructions stays comparatively sluggish 4+ years after their launch, with simply ~$10.7 Bn AUM in complete in these funds, accounting for lower than 2% of the entire AUM in actively managed ETFs. Moreover, a couple of ETFs that have been launched as semi-transparent have been subsequently transformed to the lively clear wrapper (e.g. Constancy transformed two of its semitransparent ETFs earlier this yr). Certainly, the overwhelming majority of belongings and inflows in lively ETFs are in clear lively funds (i.e. those who disclose portfolio holdings at T+1), demonstrating that portfolio transparency needn’t be an obstacle to the success of an lively ETF technique. Nonetheless, non-transparent constructions proceed to see periodic curiosity from fund managers who wish to protect their mental property on some flagship lively methods.
Possibility-based ETFs
ETFs fuelled by choices have additionally rising quick ever because the SEC’s 2020 ‘Derivatives Rule’. By setting leverage limits and threat administration requirements, the rule really makes it simpler for ETFs to make use of derivatives-based methods.
In consequence, the belongings of US option-based ETFs have grown about 600 per cent over the previous three years to $115bn, in keeping with JPMorgan. Of this, properly over half are call-put writing ETFs, adopted by “buffer ETFs”, which make up simply over a 3rd of the belongings. The rest is a motley number of different option-based methods, like 0DTE funds and structured product replication.
As FTAV has written earlier than, these choice ETFs are only a subset of a broader and rising universe of funds that derive earnings from writing choices, which some individuals suppose is suppressing volatility.
FWIW, Kolanovic and Kaplan agree that they’re a “main driver” of becalmed Vix, however don’t suppose they’re as harmful because the earlier short-Vix ETFs that blew up in 2018.
With the big quantity of volatility promoting by these overwriting ETFs, some have drawn comparisons to 2018’s Volmageddon episode, when giant volatility promoting flows through inverse VIX ETPs initially suppressed volatility, however in the end led to a volatility spike and collapse of the quick vol technique itself. Nonetheless, for overwriting ETFs we don’t see an identical mechanism at play that might produce a Volmageddon-type episode because the name overwriting methods are unlevered and don’t have any must promote fairness publicity because the market declines. That mentioned, the worth vary over which these ETFs suppress volatility is comparatively slender. If the market sells off by ~5-10%, the volatility suppressing power from these methods largely disappears, leaving markets extra weak to different promoting flows.
Single-stock ETFs
For the reason that SEC first waved them by means of in July 2022 we’ve additionally seen a rising variety of single-stock ETFs, which generally use derivatives to make it straightforward for buyers to go quick or achieve leveraged publicity to firms like Tesla, Alibaba, Coinbase and Nvidia.
You may say these are a unadorned corruption of the unique goal of ETFs designed solely to offer quick access to leverage to merchants who in all probability shouldn’t have it, however we couldn’t presumably remark. Here’s an inventory of a few of them.
In the intervening time there are about 60 single-stock ETFs listed within the US, which have cumulative belongings of $8.7bn (the overwhelming majority is in Tesla and Nvidia ETFs). That is clearly tiny in comparison with the general trade, however these are buying and selling instruments for day trades — who go out and in opportunistically — so AUM is a poor measure of their general affect.
As JPMorgan’s Kolanovic and Kaplan level out, the dynamics of every day rebalancing in derivatives imply that they’re inherently procyclical buying and selling instruments that may trigger issues in the event that they develop too giant. FTAV’s emphasis under:
A bonus is that losses to buyers in these ETFs are restricted to their preliminary funding, whereas different types of leverage might ship losses exceeding 100% (e.g. by quick promoting a inventory that greater than doubles or borrowing 50% reg T margin to go lengthy a inventory that falls by 50%+). Nonetheless, as a result of levered ETFs ship every day leverage, they underperform throughout mean-reverting markets and outperform throughout trending markets because of the every day leverage resets and compounding of returns . . . Moreover, levered ETFs rebalance in a brief gamma trend (i.e. they’ve to purchase the underlying on up days and promote it on down days), which might exacerbate volatility on their goal shares ought to these merchandise achieve materials belongings.
ETF choices
On high of all this, there’s a rising ecosystem of choices written on ETFs themselves. The excellent quantity of US ETF choices now comfortably above $600bn, up from properly beneath $200bn 5 years in the past.
Which implies that after being briefly leapfrogged by single-name fairness choices within the 2020-21 retail buying and selling mania, ETF choices are as soon as once more the second-largest phase after index choices (that are in flip more and more dominated by zero-day choices).
No less than right here there may be little change by way of range. The upswing is especially attributable to an enormous enhance in buying and selling choices on SPY, State Road’s flagship S&P 500 ETF.
SPYs common every day notional choice buying and selling volumes have tripled simply since 2021, to succeed in $409bn this yr, about two-thirds of the entire, in keeping with JPMorgan.
Choices on SPY, the Nasdaq QQQ ETF and BlackRock’s Russell 2000 small-caps ETF collectively account for about 95 per cent of all ETF choice volumes this yr. JPMorgan notes that many of the ETF choices being traded are places, so these are in all probability principally choices used to hedge an general portfolio
Lastly, there’s the emergence of crypto ETFs over the previous yr, that are too tedious to spend much more time on. However they add one other dumb facet to the ETF universe’s rising complexity.
Folks proceed to freak out concerning the progress of passive investing, usually for misguided or self-serving causes. In the event that they actually wish to discover out the place the following market stupidity goes to return from, then the parallel progress of gimmicky, derivatives-based and/or advanced ETFs is a a lot better place to look.