- The rise of exchange traded funds (ETFs) has been a key component in the overall growth of passive investments. However passive funds still represent only a fraction of total global assets under management.
- A key concern for investors is the potential of ETF liquidity mismatch to destabilise the markets that underlie them. But we are yet to witness such a significant systemic event and therefore have no yardstick to gauge the potential impact of such a situation.
- Mainstream indicators show a steady trend of improving ETF liquidity. Yet, equity ETFs have experienced liquidity air pockets during flash crash episodes in equity exchanges, albeit with limited slipover effects on credit ETFs.
- Notwithstanding the small size of ETFs relative to their market, academic literature suggests that ETF inclusion affects the price of bonds positively. The liquidity of these bonds is also affected and at times, perhaps counterintuitively, negatively so.
- The short volatility ETF carnage in February has brought attention to inverse, levered and synthetic ETFs. While they remain only a fraction of the ETF universe, they can exacerbate liquidity dynamics in vanilla ETFs – a topic of ongoing research.
ETFs market size
The exchange traded fund (ETF) market has enjoyed spectacular growth ever since the first vehicle launched in 1993. One key factor behind the popularity of ETFs is they give access to all investor types – from retail to institutional – to wide range of asset classes including, among others, corporate bonds, commodities, real estate and emerging markets - assets that can be less liquid and perhaps more opaque than more traditional investments. In this respect, ETFs can help investors further diversify their portfolios, via a liquid and low cost instrument. Some studies (BIS 2018) argue that their popularity has been supported by structural shifts in the financial advisory space, such as the rise of the so-called robo-advisers, which often include ETFs in their low-fee automated investment management services. The sector has expanded even further in recent years with the introduction of active management style ETFs.
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