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Alternative Investment

TECH TUESDAY: ETPs Grow Amid Market Volatility

TECH TUESDAY is a weekly content series covering all aspects of capital markets technology. TECH TUESDAY is produced in collaboration with Nasdaq.

As volatility in stock and bond markets continues, investors seeking more flexibility and better hedging strategies have increasingly turned to exchange-traded products (ETPs). More than 85 ETPs tracking Nasdaq indexes launched over 24 months through Q2 2022, with over $11 billion of assets under management (AUM) accumulated.

Traders Magazine recently discussed the state of the ETPs landscape with Efram Slen, Vice President, Head of Index Research at Nasdaq, and Arif Ahmed, Director, Product Intelligence of Nasdaq Global Indexes.  

The overarching questions are: What is driving industry growth in ETPs, and can it continue?

Arif Ahmed: The three main things going on in the market over the past six to eight months are volatility, inflation and the ongoing impact of the supply chain shortages that started with COVID. These themes are what policymakers, as well as investors, are focused on.

In the exchange-traded fund (ETF) market, the top category in which we see a ton of inflows relative to their size is the liquid alternative asset category. So, what is a liquid alternative ETF? It used to be that leverage and inverse products were called “alternatives,” but now that definition has broadened to hedge fund-like funds that trade on the public market in an ETF or mutual fund wrapper. 

Arif Ahmed

Liquid alternative assets use options and other derivative instruments to provide a hedging strategy, like a risk management strategy with equity and fixed income exposure and an option overlay with a tactical aspect that provides some hedge while having equity exposure. Another popular strategy is the anti-beta strategy, funds that are equity market neutral by being long in low beta stocks and shorting high beta stocks. These types of products have done quite well this year because the volatility in the market has benefited these hedging strategies. Liquid alternative assets, along with more income-generating funds with less volatility than the broader market, are clear winners in 2022.

In the first six months of the year, global ETFs have seen a nearly $300 billion influx, a backdrop of the S&P being down 20%. That’s historical – we have never seen those flows with the broad market down that much. In light of market conditions, investors have been getting into alternative asset funds, such as an income generation fund with buy-write strategies where you hold the underlying equities and write calls on those equities to give you downside protection. 

Efram Slen

Efram Slen: There are two reasons people are looking to options overlay strategies: incremental higher yield associated with premiums and downside risk mitigation. As people continue to better understand the benefits of options and options-based products, we expect the space to continue to grow very quickly. 

Many of the options based ETPs are actively managed. Not as many are passive, though they’re doing well themselves. For example, the Global X Nasdaq-100 Covered Call ETF (QYLD) is the world’s largest passively managed ETF and tracks the Cboe Nasdaq-100 BuyWrite V2 Index™ (BXNT™). It currently has $7.25 billion in AUM after having $2.4B of YTD inflows.

Arif Ahmed: We’ve seen consistent net flows into alternative products since essentially Q3 of 2020. Investors want more exposure to this product type as they become more sophisticated. They’re not going to be happy anymore with just a plain-vanilla, single beta, broad market fund that gives them a little bit of alpha. Investors want access to what used to be restricted to sophisticated investors who had to go through a hedge fund for this exposure. 

The trend toward alternative products is here to stay. On the Nasdaq side, this group of funds has brought in $11 billion of inflows year-to-date. 

Efram Slen: In typical market environments, we don’t expect inflows in aggregate into long and short-leverage products tracking the same space simultaneously. Usually, there are outflows from one and inflows into the other. But now, people are unsure what to expect, so they are betting on both sides of the equation.

Looking at the full suite of ETPs tracking Nasdaq Indexes, you’d expect the Invesco QQQ ETF (QQQ), the largest ETF tracking the Nasdaq-100 Index® (NDX®), to be in the fray, and it has been with annual inflows, up $2.5 billion. However, that doesn’t tell you much. I’ll break down the top ETPs by inflows tracking our indexes outside of QQQ as they are very representative of the ETP market inflows this year.

The First Trust Rising Dividend Achievers ETF (RDVY) tracks the Nasdaq US Rising Dividend Achievers Index™ (NQDVRIS™), an equity dividend-oriented index that includes a quality overlay, and is a top product by inflows, up $2B. The QYLD mentioned above, a covered call options ETF, was up $2.4B. Also on the top of the list is the Invesco BulletShares 2024 Corporate Bond ETF (BSCO), another Nasdaq-100 ETF by Invesco in the US (QQQM) and a Nasdaq-100 product out of China. Lastly, the final ETF in the top 10, with more than $1 billion inflows for the year, is the VictoryShares US EQ Income Enhanced Volatility Wtd ETF (CDC). The CDC tracks the Nasdaq Victory U.S. Large Cap High Dividend 100 Long/Cash Volatility Weighted Index™ (NQVWLDC™), a volatility-weighted index that can tactically reduce its exposure to the equity markets during periods of significant market decline and reinvests when market prices have further declined or rebounded.

Summarizing in no particular order: options, investment grade corporate bonds, volatility weighted with tactical risk reduction, dividend strategy with quality overlay, and Nasdaq-100® beta and leveraged/inverse tracking products top the list. Again, very consistent with broad trends. Investors are looking for ways to mitigate risk, search for yield to combat high inflation and hedge their portfolios during choppy markets.

Arif Ahmed: The Nasdaq-100® is still a big story for us; people still believe in these innovative companies. It’s shown remarkable resilience over the last three decades through various market conditions. But we have many other indexes that are the underlying strategies for ETFs. For example, our cybersecurity index has had almost $700 million in inflows this year through the ETFs that track it, and our semiconductor index has well over $1 billion in aggregate flows to those products. So, sector funds are still attractive, and the brand recognition as it relates to Nasdaq and Nasdaq-100® remains strong. 

Efram Slen: A key message is that people are pouring money into strategies they expect to do well and transcend the current market environment. Cybersecurity and semiconductors aren’t necessarily technology but more like utilities used in seemingly everything. So, while the overall markets might be choppy, there will be pockets like those industries that continue to resonate with investors.

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