Are ETFs the New Futures?

Chidem Kurdas

Exchange-traded funds are becoming a favorite instrument for bond traders, in part replacing individual securities, futures and swaps.

Fixed income is migrating to ETFs, says Mark Wiedman, global head of iShares, the ETF business of asset management behemoth BlackRock. He pointed out that ETFs are often cheaper than futures as financial instruments.

That is, you may be able to profit from your view of where a market is going at lower cost with an ETF than with futures contracts on that market.

Many hedge funds and other market players have long preferred to trade futures and options rather than stocks or bonds directly, because futures require less capital.

But equity ETFs – baskets of stocks – became very popular in the past decade and are now widely used for trading purposes, in addition to long-term portfolio building. The preference for bond ETFs as a substitute for futures or individual bonds is more recent.

Mr. Wiedman described HYG, BlackRock’s flagship high-yield corporate bond ETF, as an example. Trading in HYG as a percentage of high-yield-bond trading has grown substantially since 2009.

But there was a dramatic spike after Federal Reserve Chairman Ben Bernanke made his famous speech in May 2013, announcing that the Fed intended to taper off its bond purchases, also known as quantitative easing. Investors and traders used HYG to change their exposure to interest rates in view of the coming taper.

While the growing use of bond ETFs as a trading instrument may not be quite as radical as orange becoming the new black, it reflects a long-term shift in the debt market. Banks are no longer dealing in bonds as much they used to, mostly because their proprietary trading desks have been shut down by regulatory decree emanating from the Dodd-Frank Act.

With banks reducing their participation, the bond market has less liquidity. As a result, trading bonds is riskier, with wide spreads between buy and sell prices. By contrast, some ETFs like HYG trade a lot and have tight spreads.

As trading spiked in May 2013, the market in HYG shares functioned well, according to Mr. Wiedman.

In general, popular ETFs tend be highly liquid instruments, easy to buy and sell. HTG trades every day and prices in new information, whereas many bonds do not trade on a daily basis, Mr. Wiedman said, speaking at a conference.

It should be kept in mind that BlackRock has a big interest in promoting all uses of ETFs—being the world’s largest ETF provider with the iShares franchise and almost $1 trillion in assets in this type of fund.

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One Response to “Are ETFs the New Futures?”

  1. Bond ETFs Hold Up Amid Volatility | HedgeFundSmarts Says:

    […] a range of investors, including retail customers looking for cheap and easy stock or bond exposure. Hedge funds use ETFs extensively as low-cost instruments for trading, somewhat like futures. This has long been the case with equity ETFs but bond ETFs are also becoming popular for […]

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