This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article features Wesley Gray, chief executive officer and chief investment officer of Alpha Architect based in Broomall, Pennsylvania.
One class of financial products that has recently experienced truly explosive growth is exchange-traded funds.
But how does this growth affect the market? Do market prices on the underlying assets get more efficient? Are they more volatile? How is market liquidity affected?
These are difficult questions, and academic researchers are finally getting around to addressing these questions. Lin William Cong and Doug Xu, researchers from the storied finance program at the University of Chicago, tackle some of these kinds of questions in their newest paper, “Rise of Factor Investing: Asset Prices, Informational Efficiency, and Security Design." But before we dig into to this fascinating paper, we’ll cover a quick background of the ETF market and why this paper is an important contribution.
Incredible ETF Growth Rate
While exchange-traded products have been around for more than 25 years, their history over the past decade has fundamentally altered the financial landscape for investors. Consider the chart below (sourced from etf.com), which shows the number of ETFs and their growth of assets under management since 1993:
There are nearly 2,000 exchange-traded products on the market, and the AUM growth is more than $2.4 trillion. Furthermore, according to the Financial Times, ETF assets surpassed hedge fund assets during 2015.
Institutional investors increasingly allocate to ETFs and ETPs. A recent study from Greenwich Associates found that two-thirds of U.S.-based institutional investors allocated to ETFs, with 43% of these investors allocating less than 10% of assets to them.
Today ETFs account for almost one-third of U.S. equity trading volume (for those seeking to learn more, check out Eric Balchunas' book, “The Institutional ETF Toolbox,” which offers an overview of ETFs and how they are used by institutional investors).
Clearly, ETFs are becoming more popular, but this begs the initial question: Why?