Risk-on, risk-off driving ETF trading

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More institutional investors are making greater use of exchange traded funds to help with portfolio construction in the current “risk-on, risk-off” trading environment, according to a survey by Credit Suisse’s Trading Strategy group.

Credit Suisse found that more than half of the institutional investors it surveyed were using ETFs more than in the past.

Almost 30 per cent said they were using ETFs more frequently than before because the risks of trading single stocks were so high while more than a quarter said they would continue to use ETFs even if macro-economic driven “risk-on, risk-off” trading conditions were to subside.

Phil Mackintosh, global head of trading strategy at Credit Suisse, said ETFs by their nature were good for expressing macro views and were cheap ways to buy exposures if single stock bets offered little extra alpha.

“In this macro-driven world, it is no surprise that ETF trading has grown to the current high levels activity – representing $1-in-$4 traded in the US stock market recently,” said Mr Mackintosh.

Credit Suisse also pointed out that mutual funds were still not “heavy users” of ETFs with one-third of those surveyed not making use of ETFs at all.

Only 7 per cent used ETFs “almost exclusively” even though this is an increasingly popular strategy among macro hedge funds.

Credit Suisse’s ETF survey was part of a broader analysis of US equity trading volumes which sank to a five year low in July.

One factor explaining the decline in trading volumes has been the decline in risk appetite among hedge funds and portfolio managers due to numerous macro-economic risks, such as the threats of sovereign defaults in Europe and the looming “fiscal cliff” if cuts in US public spending are not agreed.

The average daily traded value of US equities was $156bn in the first seven months of 2012, down 10.3 per cent on the same period a year ago.

A recovery in equity trading is not expected quickly. Credit Suisse said that 83 per cent of those it surveyed thought that it could take between two and five years for trading volumes to recover.

ETFs have not been immune from the decline in trading. The average daily traded value of US listed ETFs was $62bn in the first seven months of 2012, down almost 14 per cent on the same period a year ago, according to Credit Suisse.

Mr Mackintosh said the outlook for ETF trading volumes depended on a number of competing drivers whose importance was difficult to predict.

Macro-economic risk factors might recede, which would hurt ETF trading. Alternatively, those risk factors could deteriorate further, which could help ETF trading volumes.

On the plus side, Mr Mackintosh said the trend for retail investors and mutual fund managers to make more use of ETFs was still increasing.

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