Exchange-Traded Products Ready for Liftoff

Terry Flanagan

Exchange-traded products like ETFs and ETNs are eclipsing traditional equities as investors look beyond fixed income for high-yield products.

“ETFs, which make up $1.5 trillion in assets, have grown much faster than equities,” said Rich Repetto, principal, equity research at Sandler O’Neill & Partners, at a press briefing hosted by Liquidnet. “Active managers need to prove they can beat the phenomenon of efficient ETFs and passive investing. For Baby Boomers, the runway of investment is now shorter. Are they willing to take the same risks as they would in 2000?”

Exchange-traded products are likely to absorb much of the cash that’s sitting on the sidelines or invested in fixed income.

“Our economic research team suggests that the Great Rotation is not yet happening,” said Dave LaValle, head of exchange-traded products at Nasdaq OMX. “We have seen successful asset growth in non-fixed income products that aim for yield, such as options overlay strategies or dividend reinvestments that have caused investors to begin to shift from fixed income into more diverse asset classes.”

Dave LaValle, Nasdaq OMX

Dave LaValle, Nasdaq OMX

LaValle noted the “generational component” that the Baby Boomers represent, in particular a need for instant access to investments. “Mutual funds had been the principal vehicle to access multiple asset classes, but we are seeing the mix changing toward exchange-traded products. From an exchange perspective, we will see continued proliferation of ETPs versus traditional forms of equity investments.”

Nasdaq OMX Group has launched the Market Quality Program (MQP), an optional listing program that allows exchange traded fund (ETF) issuers to pay market makers in order to improve the liquidity and quality of the markets in MQP products.

Through the MQP, an ETF issuer will pay a basic annual fee into NASDAQ OMX’s general fund which will be rebated quarterly to qualified market makers. Market makers will benefit from the program’s quarterly rebate payments in exchange for a demonstrated commitment to enhance the quality of the markets in registered ETFs.

Market maker performance will be measured by time and size quoted at the National Best Bid and Offer and depth of displayed liquidity.

“Our market is primed for additional ETP listings and stronger issuer partnerships in 2013 as we look to leverage our relationships in the market making community to increase ETP liquidity and broaden the pool of ETP liquidity providers,” said LaValle. “The MQP will accelerate our momentum within the ETP community.”

The long-awaited “Great Rotation” of assets out of fixed income following an uptick in rates will not necessarily reverse the long-term decline in institutional trading volume in U.S. equities, according to new research from Greenwich Associates.

Eighty-one percent of the buy-side institutions participating in Greenwich Associates 2013 U.S. Equity Investors Study think U.S. equity market turnover will fail to rebound to pre-crisis levels by 2014.

The past 12 months brought no recovery in trading activity, despite net inflows to U.S. equity portfolios among the institutions taking part in the study. More tellingly, the longer-term decline in trading activity has taken place amid historically strong equity markets.

“Given these patterns, it’s possible that even with a strong rally sparked by an influx of assets from investors fleeing fixed income, trading activity could be dampened by a continuation of the low volatility and volume that has characterized the recent run-up,” said Greenwich Associates analyst Kevin Kozlowski.

At about 6.3 billion shares, first quarter 2013 daily trading volume in U.S. equities is down by a third from the 2009 market high of roughly 9.3 billion Equity brokers suffering from the pronounced slowdown in U.S. equity trading volumes had been hoping that an increase in interest rates might jumpstart trading activity. But recently, brokers have started planning for a new market normal in which trading volumes, commission payments and brokerage revenues hover close to today’s depressed levels.

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