Quantifying ETFs

The ETF Backdrop

ETFLogic was created to bring transparency to the fast-growing ETF market. Today, more than 1 in 3 shares traded in the US marketplace is an ETF. ETF assets under management have grown to $3 trillion and are expected to double in the next three years. On average, there is a new ETF listing every single day, adding to the more than 2000 products already in existence. US-listed ETF assets surpassed that of hedge funds earlier this year.

The ETF revolution has also expanded globally, with products listed in over 50 countries and accounting for an additional $2 trillion assets and 4000 more products.

This demand is being driven by several benefits over more traditional funds: daily fund transparency, tax efficient structures and all-day trading — all of which have brought these products to the top of investor’s minds.

Regulation has largely kept pace, allowing market participants to test the waters with new investment concepts and ideas. Current proposals for new ETF structures hope to combine actively-managed strategies with the all-day-trading benefits of ETFs. Initiatives like this will further chip away at the $4 trillion of assets tied up in actively managed mutual funds.

The rise of ETFs has created an interesting dynamic with the underlying assets they track. Average ETF ownership of the US equity market stands at 5% and is growing rapidly. This ownership can be higher in many individual cases — over 10% in about a third of US publicly traded companies. All this means there are deeper relationships that need to be understood by both corporations and active managers.

What we do

ETFLogic helps our clients make better investment decisions. ETFs have democratized access to both global markets and asset classes. This wealth of choice creates new challenges in choosing the right investment, understanding the cost and risk profile of those investments and constructing well diversified portfolios.

Our clients use ETFLogic to get our TruLiquidity scores — a quantitative metric to quickly gauge whether an ETF matches their liquidity needs. Some ETFs may not trade or have a viable on-exchange market — however they may be good investment ideas. In other cases, the ETF may be much more liquid than the underlying basket. TruLiquidity applies a transaction cost model to both the ETF and the basket to tell you right away how much liquidity you can acquire via that name.

ETFLogic Scorecard Example

Our Overlap Analysis, or transition management tool allows investors to visualize the cost and risk dynamics of shifting their portfolio with ETFs. Many investors may put undue emphasis on investing in the lowest cost ETFs in a particular peer group. However, there may be subtle differences in that fund’s construction (factor tilts, rebalancing methodologies, etc…) that drive outperformance over that cost differential in the long run.

Our multi-factor analysis allows us to stylistically characterize ETF performance on various fundamental and technical factors, such as Value and Growth, Market Cap, Quality or Profitability, Dividends, Momentum and Volatility. Such factors help explain stock returns in terms that investors understand. With the rise of smart-beta and factor investing, these tools also help distinguish between similarly labeled ETFs. For example, the half-dozen ETFs labeled as both Large Cap and Value may have different Quality and Momentum tilts, contributing to slightly different returns over the same period.

In the screenshot you see an example of our ETF Scorecard. These can be customized and emailed to investors, providing a uniform and immediate way to communicate a fund’s most important characteristics. Our quantitative suite of tools allows for a deeper look into ETF and portfolio dynamics: portfolio transition profiling across liquidity and risk, digging into the actual holdings, and screening for particular fundamental and technical factors.

A Deeper Look

In a subsequent post we will dig into a more quantitative analysis and highlight the implications of the rise of ETFs. As we alluded to earlier, as ETF’s grow in assets and in complexity, the assets they hold are affected by daily inflows and outflows, rebalancing and methodology changes. These underlying movements are of great importance to both active managers and corporations. Active managers need better guidance on how to manage risk. Corporations care about who their investors are and how they will vote in the next shareholder meeting.

We are in the middle of an exciting new time as access to markets and products opens up. ETFLogic is about empowering investors with the right tools to make better investment decisions in this new environment.