MSCI: Next-Generation ETF Analytics

ETF Trends

We’ve heard it directly from institutional clients over the past few years: The increasingly complex ETF market is making it harder for portfolio managers and investors to differentiate between funds.

With more than 1,400 ETFs on the market, making choices is not easy, and the seemingly small differences between funds are often much bigger than they appear on paper. And in a $1.4 trillion dollar industry, things are getting even more complicated.

Capturing accurate risk and return profiles of ETFs that lack holdings transparency has remained elusive. A thorough grasp of the risk and reward profile of an ETF is no longer a matter of looking over the list of portfolio holdings in a prospectus or tracking the index it follows. Often, investors and advisors buy on brand, choosing the most popular ETF. As a result, advisors are calling for fast and reliable tools to choose. Now more than ever, the industry is pushing for tools that answer the key questions:

  • Is my ETF tilting away from the target index? Are there any potential style drifts? Where are those potential tilts coming from?
  • What are the risk exposures of my ETF? What are the sources of tracking error? Which factors are driving returns?
  • How is my ETF correlated to other portfolio constituents, other ETFs and other asset classes?
  • How effective is my hedge? Am I incurring any unwanted risk exposures?

The Urgency

The transparency that was previously a hallmark of the ETF market has been blurred as the market has seen explosive growth in a short period of time and tools to help navigate the market have been slow to keep up.

In some cases, actively managed ETFs undergo frequent changes that aren’t instantly visible to the market and, in fact, may take days and even weeks to be released to investors. What’s more, the alterations can effectively bring about marked style drift.

New analytical tools will be a substantial benefit to a maturing ETF marketplace. They will make it possible for investors to shed more light on both active and passive portfolios and ways to better incorporate them into a variety of asset allocations. That, in turn, will help investors feel a greater level of confidence about a broad range of investments.

Tools that leverage global multi-asset class models will provide a granular look at ETFs and ETNs, expand risk coverage to include levered, inverse and multi-asset class instruments, increasing transparency in understanding market exposures and any potential style drifts from the prospectuses.

Approaching the matter from two angles helps to unearth weightings, positions and other factors to a very high level of accuracy. The detailed mapping of portfolios also makes it possible to assign a variety

of specific risk values to any given ETF including r-squared calculations. And to reflect changes occurring in varying timeframes, so investors can focus on both short-term and long-term movements as needed.

Next page: The impact

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