RBC Dexia magazine

ETF fundamentals

The numbers are adding up

June 2010

While long considered a niche product, particularly in Europe, ETFs are shifting into the mainstream as investors look for diversification opportunities.

The proof is in the numbers. At the end of December 2009, the global ETF market grew a resounding 45% year over year. And the final tally at the end of the year was a market that stood at approximately USD 1 trillion in assets. This reflects phenomenal growth, with the biggest surge coming from Europe where ETF assets grew over 56%.

ETF growth continued throughout the first quarter. At the end of Q1 2010, the global market consisted of 2,131 ETFs (+12.4% YTD) with 4,133 listings (including interlisted ETFs), from 123 providers, listed on 42 exchanges worldwide. Global ETF assets grew 7.4% YTD*. Moreover, the number of ETFs in Europe now surpasses the US with 910 ETFs versus 814, respectively.

And the pattern looks set to continue both in terms of asset growth and asset classes, despite the recent hit during the market correction. Commodities, emerging markets, and leveraged and inverse ETFs are the categories that are attracting the greatest proportion of investors. Traditional asset classes are well represented in the ETF market today but demands for greater diversification are resulting in a new wave of more creative and unique ETFs, such as life cycle funds, and ETFs of ETFs.

Why the keen interest? A key driver in the growth of ETFs and their attractiveness are transparency, liquidity and cost efficiency—their total expense ratios are typically between 60 and 80 basis points below traditional mutual funds.

However, despite the increased transparency ETFs offer, not all are created equal and investors need to do their homework to clearly understand what they are buying, as ETF structures are becoming more sophisticated and complex.

For custodians and administrators, ETF servicing requirements are more challenging in comparison with traditional mutual funds. ETFs demand more sophisticated and automated trade capture capabilities, as well as fund accounting and valuation technologies linked to custody platforms. A global network for efficient and timely settlement of underlying instruments is essential, as is an understanding of what it takes to move from a timeframe of daily asset valuation to real-time valuation with the indicative NAV.

What is an ETF?

An ETF is not simply a mutual fund that is listed and traded on a stock exchange. Rather, it is a hybrid between a stock and a mutual fund that combines features of both investment types in a single vehicle. ETFs have fund-like characteristics in that they calculate Net Asset Values, contain a basket of securities and usually track an index or a benchmark. Yet they also have stock-like characteristics in that they are continuously traded on stock exchanges through brokers, can be shorted, and are both marginable and lendable.

Traditional funds can only be bought at the end of the trading day and all investors receive the same price. ETFs, on the contrary, can be continuously bought and sold throughout the trading day and are subject to the same daily price fluctuations that normal listed stocks experience. Real-time valuation of ETF assets is expressed through an indicative Net Asset Value (iNAV), which usually is updated several times per minute.

* www.blackrock.com