Tadas Viskanta Abnormal Returns Winning Strategies from the Frontlines of the Investment Blogosphere

Author:unknow
Format: epub

The ETF-ization of Everything

The ETF revolution has scooped up all manner of asset classes over time. Starting with domestic equities, international equities, fixed income, international fixed income, currencies, and commodities, the industry pretty much has the asset class scene covered. Within these niches, industries are now well represented alongside more narrow thematic plays, alternate-weighted indexes, and strategies that seek to replicate hedge fund returns and even plays on volatility. There are numerous examples that show that when one of these ETFs becomes popular, it can actually change how the underlying market trades.

This can occur when the ETF becomes so popular that in a certain sense it becomes the market. We saw this in the case of crude oil and natural gas ETFs, which were among the biggest buyers of futures on these commodities. Some market players believe that the complex of ETNs that tracks the CBOE Volatility Index (the VIX) now has a disproportionate effect on how VIX futures trade. The sponsors of these funds likely had little belief that their funds would become popular enough to influence markets, but they did. In a very real sense, these funds became the tail that wagged the dog. Not only do very popular niche funds risk changing the dynamics of the underlying market, but they also represent a warning sign to investors that the particular market has become overheated.

Another way in which ETFs can change a market is by making available an asset or strategy that was previously off-limits to the vast majority of investors. A prime example is the physical gold market. Prior to the introduction of the SPDR Gold Trust back in November of 2004, investors who wanted gold exposure were forced to go through the costly process of buying physical gold and storing it. Otherwise they could purchase futures contracts on gold or the shares of gold miners. The introduction of the SPDR Gold Trust, now the second largest ETF by assets, has changed the gold-buying calculus.

Exchange-traded gold funds have made it a trivial exercise to buy, sell, and trade physical gold. Anyone with a brokerage account can participate. This has been a boon to investors who have been in the fund from the time of its launch, since they have seen the price of gold increase from $444 to nearly $1,800 an ounce at present.12 Gold has been viewed for ages as a store of value or safe-haven asset. The question for gold investors is whether having so much physical gold tied up in ETF-type structures has changed the way investors look at gold. Said another way, is gold simply another ticker symbol on investors’ screens that investors now feel comfortable trading at a moment’s notice?

One of the great tricks that ETFs have been able to accomplish is to generate liquid vehicles for assets that are generally less liquid. This has been the case with corporate bond ETFs that track investment-grade and high-yield bond indexes. The iShares iBoxx Investment Grade Corporate Bond Fund and the iShares iBoxx High

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