State Street Sees Untapped Potential for Use of ETFs

State Street says the number of ETFs has exploded over the past two decades. Through the first three quarters of 2009, ETFs accounted for 33% of all U.S. stock trading volume and, as of the end of September 2009, global ETF assets under management (AUM) had grown 31% year-to-date to $933 billion spread across 1,819 products, according to the report.

State Street admits that institutional investors have embraced ETFs, capitalizing on their diversification benefits, reasonable expense ratios, tax efficiency, and liquidity. The report notes that seventeen of the 20 largest mutual fund complexes and 15 of the 20 biggest hedge funds invest in ETFs, and all of the largest university endowments include ETFs in their top-10 holdings as well.

However, many institutions still fail to leverage ETFs to their full potential due to lack of familiarity with all of the new products and confusion over how best to use ETFs in their portfolios, State Street contends.

The firm’s latest Vision Focus report provides examples of current methods of employing ETFs by some institutional investors for optimal effect, including cash equitization, completion and core-satellite strategies, strategic asset allocation and tax management, among other uses. It also highlights regional differences in the development of the ETF market and provides a discussion of recent regulatory changes.

“While product innovation has been significant throughout the industry over the past two decades, the rush of new products has been a source of confusion, even for seasoned institutional investors,” said James Ross, senior managing director at State Street Global Advisors, in a press release. “With a heightened level of product development, short performance records and fluctuating regulations for some of these product offerings, selecting the best ETFs can be a challenge. ETFs with reasonable spreads, sufficient liquidity, low expenses, minimal tracking error, and well-constructed underlying indices provide the best prospects for success.”

A copy of the latest Vision Focus reported can be downloaded from http://www.statestreet.com/vision.