Institutions shift to exchange-traded funds as futures grow costly

Tue Jul 29, 2014 3:10pm EDT
 
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By Ashley Lau

NEW YORK (Reuters) - Institutional investors, like endowments and sovereign wealth funds, are trading some of their stock futures contracts for exchange-traded funds, an action they say saves them money and effort while providing comparable returns.

It is a shift prompted by the regulation-driven rising cost of futures trading, and it has ETF issuers such as BlackRock Inc (BLK.N: Quote) salivating. In the past six months, the largest U.S. ETF provider said it had some $2 billion in trades into ETFs from investors that previously bought futures and swaps with that money.

The shift underscores a broader trend on Wall Street, where investors are seeking alternative ways to access markets as banks cut back on trading operations in the face of higher capital requirements and other regulations. That in turn has driven up the cost of derivatives such as futures contracts and is making some securities, including individual bonds, harder to find.

In pre-crisis 2008, a typical stock futures contract held for a year would cost around $100 annually for $100,000 of contract value. Now, it would cost between $300 and $500, as bank dealers mark up these contracts to cover the costs of the higher capital requirements.

At the same time, ETF price wars among major providers are driving down management fees and resulting in very cheap access to funds tracking broad stock indexes.

"Unless the cost of capital changes, then ETFs will take more and more share of the futures and swaps market," says Daniel Gamba, who oversees BlackRock's iShares institutional business in the Americas.

To be sure, most of the money in the futures market will stay there because it is invested by those that want the kind of leverage they cannot get from ETFs, says Chintan Kotecha, a New York-based analyst at Bank of America Merrill Lynch.

But with the entire $2.6 trillion ETF market but a small fraction of the $48 trillion invested globally in futures and swaps, even an incremental move away from futures leaves plenty of room for increased ETF sales, says Gamba.   Continued...

 
Traders work on the floor of the New York Stock Exchange shortly after the market's opening in New York July 28, 2014. REUTERS/Lucas Jackson