“Smarter” investment strategies in ETFs

Benjamin Cyrot, head of European Fund Distribution at Nomura looks at how the evolving nature of ETFs has brought new and more innovative investment techniques

Investment in exchange-traded funds has grown dramatically over the past five years, as the vehicle’s key characteristics – high degrees of transparency and liquidity, absence of credit risk, and the ability to trade intraday – have found increasing favour with investors around the world.

According to consultants McKinsey & Co, the assets held in ETFs globally are likely to increase from the US$1,500bn that was in place at the end of 2010 to between $3,100bn and $4,700bn by 2015.

Given how important credit exposure and liquidity have become to all categories of investor since the financial crisis in 2008, this forecast is perhaps not surprising, and the continuing evolution of the market should provide further impetus for growth.

For while the first generation of ETFs for the most part offered “passive” investments in a limited number of indices – albeit ones that their investors could trade swiftly and easily at any time of their choosing – the current generation of vehicles that are now coming to the market offer much greater choice of investment strategies and asset classes.



Next generation ETFs
Whereas a traditional ETF would typically offer a simple, one-sided bet on an investment in an index (usually a long position), a new generation ETF can now offer a range of much more sophisticated and alternative type strategies – although still in the vast majority of cases based on a systematic approach rather than the active intervention of an individual fund manager.

The choices now include the global hedge funds indices replicating strategy, (which aims to achieve hedge-fund level returns by replicating the returns of a hedge-fund database using only highly liquid instruments and at a much lower cost, i.e. futures) and specific alternative investment styles such as the 130/30 long-short strategy, which attempts to outperform the benchmark stock index by leveraging some long-stock bets while simultaneously taking some selected short positions.

There is also the active alpha strategy. For example, there is an ETF that references the Man GLG Europe Plus Index, which aims to outperform a long-only European equity benchmark by 2% to 5%.

There are also ETFs that offer a combination of long, short and leveraged investment strategies in currencies and commodities, as well as inverse ETFs that offer short exposure to an equity index without actually taking a short position. The vehicle offers exactly the opposite return of the index in question, based on daily or monthly compounding frequencies.