Why are ETFs becoming more and more complex?

Assets in the global ETF industry have grown by approximately $3 trillion since the last report, thanks to continued inflows and rising markets. That’s more than the total market capitalization of the FTSE 100, or about one Nvidia these days.

JPMorgan’s 20th annual report highlights how ETFs are becoming more diverse and complex. This is especially true in the United States, where a 2019 ETF rule sparked strong financial innovation.

While the majority of money continues to flow into classic passive funds, the proliferation of thematic ETFs, factor ETFs, multi-asset ETFs, active ETFs, and derivatives-based ETFs is accelerating. As JPMorgan’s Marko Kolanovic and Bram Kaplan write:

"...For the fourth consecutive year, the majority of new ETFs are actively managed. Additionally, risk-managed/defined, factor, call/put-written and thematic funds remained significant areas of interest for issuers over the past year, together accounting for nearly half of all new ETF issues. Cryptocurrency ETFs have been another major area of interest over the past year; they have accounted for approximately 5% of new fund issues and have attracted over 40% of AUM in newly issued funds."

The growth of actively managed ETFs has been particularly strong, as more asset managers use this structure for new funds, converting old funds, or as a share class of existing funds.
JPMorgan estimates that actively managed ETFs have accounted for more than 60% of all new ETF issues in the U.S. each year since 2020. Their assets have grown about 70% over the past year to about $670 billion. They accounted for a quarter of all inflows into U.S. ETFs over the past year.

Types of ETFs

Source: J.P. Morgan Quantitative and Derivatives Strategy

As JPMorgan points out, this isn’t really making a dent in the broader shift toward passive investment strategies — whether in mutual funds or ETFs. Rather, active ETFs are only slightly eroding the market share of the mutual fund structure
Options-based ETFs have grown rapidly since the SEC’s ’Derivatives Rule’ of 2020. By establishing leverage limits and risk management standards, the rule makes it easier for ETFs to employ derivatives-based strategies.

As a result, U.S. options-based ETF assets have grown about 600% over the past three years to $115 billion, according to JPMorgan. Of these, well over half are ETFs with call-put writing, followed by "buffer ETFs", which represent just over a third of the assets. The rest is a variety of other options-based strategies, such as 0DTE funds and structured product replication.
These options-based ETFs are just a subset of a larger and growing universe of funds that derive income from options writing, which some believe is suppressing volatility.

Since the SEC first authorized them in July 2022, we’ve seen a growing number of single-stock ETFs, which typically use derivatives to make it easy for investors to short or gain leveraged exposure to companies like Tesla, Alibaba, Coinbase, and Nvidia.
There are currently approximately 60 individual stock ETFs listed in the US, which have cumulative assets of $8.7 billion (the vast majority are in Tesla and Nvidia ETFs). This is small compared to the overall industry, but these are trading tools for day traders — who enter and exit opportunistically — so AUM is a poor measure of their overall impact.
As JPMorgan’s Kolanovic and Kaplan point out, the dynamics of daily rebalancing in derivatives mean they are inherently procyclical trading instruments that can cause problems if they grow too large.

Add to all this a growing ecosystem of options written on the ETFs themselves. U.S. ETF options’ outstanding volume is now comfortably above $600 billion, up from well under $200 billion five years ago.
This means that after being briefly overtaken by single stock options in the retail trading euphoria of 2020-21, ETF options are again the second largest segment after index options (which in turn are increasingly dominated by zero-day options).

At least here there is little change in terms of diversity. The increase is primarily driven by a huge increase in options trading in SPY, State Street’s flagship S&P 500 ETF.
Average daily options trading volumes on SPY have tripled since 2021 alone, reaching $409 billion this year, about two-thirds of the total, according to JPMorgan.

SPY options, the Nasdaq QQQ ETF, and BlackRock’s Russell 2000 small-cap ETF together account for about 95% of all ETF options volume this year. JPMorgan notes that the majority of ETF options traded are puts, so these are likely mostly options used to hedge an overall portfolio.
Finally, there is the emergence of cryptocurrency ETFs in the last year which adds another aspect to the growing complexity of the ETF universe.

Original article published on Money.it Italy 2024-07-19 06:17:00. Original title: Perché gli ETF stanno diventando sempre più complessi?