Part 1 – An Overview of the Global Exchange Traded Funds (ETFs) Market

Overview of Exchange Traded Funds

Note: This is a 5-part series that covers the following areas

  • Part 1: An overview of the ETFs market globally
  • Part 2: Evolution of ETFs -1st -4th generation ETFs
  • Part 3: The Future of ETFs (post 2030)
  • Part 4: The Risks & Rewards associated with exotic ETFs
  • Part 5: An overview of African ETF Market-Challenges faced

Recently in April 2020, oil prices traded in negative territory for the first time ever as lackluster demand and scarce storage in the face of the coronavirus pandemic meant that sellers effectively were paying buyers to take a barrel of crude oil off their hands. Although this event happened just one day before the futures contract expired, the effect on broader oil stocks was limited; institutional players had mostly rolled their futures positions to the next month’s expiration. But the implications of this event went well beyond the niche world of physical-delivery oil futures — it had a profound impact on the exchange-traded products that are based on these futures contracts.

Exchange Traded Funds (ETFs) were launched in 1993 in the United States. Since then, they have changed the face of investing over the past two decades. Offering a diverse array of investments at a low cost, these open-ended, index-based funds started out as transparent, liquid, efficient and simple instruments that trade on an exchange like stocks: Borrowing shares to sell short, placing limit or stop-loss orders and buying on margin are all permissible. Although ETFs have some similarities with mutual funds — both represent professionally managed baskets of securities — ETFs are characterized by higher liquidity and greater flexibility because they can be bought and sold over the course of a day.  According to Stoyan Bojinov, typical ETFs are less actively managed than mutual funds, hence they tend to have lower management fees. Moreover, when an investor wants to buy shares of a mutual fund, the process requires an understanding of loads and redemption fees.

ETFs have had a material effect on the way investors access markets. The funds appeal to long-term investors, who use them for index investing, as well as more-active traders with short-term horizons. Compared with mutual funds, ETFs are generally more transparent and tax efficient. Portfolio holdings are disclosed daily, in contrast to mutual funds, which report them quarterly with a month’s lag. Most ETFs are passive index funds with very low turnover — and hence few realized capital gains. When there are gains, they are rarely distributed due to ETFs’ distinctive creation and redemption mechanism

The ETF growth story is best captured by looking at both the number of funds in the marketplace and the value of their assets. Figures 1 shows the number of ETFs in Africa. This number has been linearly increasing over the past few years alongside a non-linear increase in number of asset classes. The nonlinear asset growth can be attributed to the popularity of the most liquid ETFs, which have garnered substantial inflows. The funds’ liquidity, based on average daily dollar volume traded, has also grown significantly over the past decade, after a slight lull in the wake of the 2008–’09 global financial crisis. Starting from about $70 billion in assets Exchange-traded products have evolved substantially from the simple structures of the first generation. These passive products typically held baskets of stocks or other securities reflecting the composition of the index they were designed to track. Subsequent generations of ETFs were able to replicate the index’s performance by holding a subset of stocks or using swaps or other financial derivatives. But the rapid growth of the ETF market and the increased variety and complexity of exchange-traded products, including those that incorporate active management strategies or use leverage, have introduced a whole new set of risk factors. The industry’s future growth is likely to depend on the willingness of investors to accept the added risks and increased complexity of the products, and to embrace the active pursuits of ETF providers

Number of ETFs in Africa

Figure 1 :       Source: ETF Stream