ETFs Are Bigger Than Hedge Funds And Hedge Funds Are A Big Reason Why

In July, ETFGI, a London-based ETF research firm, confirmed that total assets under management at the world's exchange traded products, including ETFs and exchange traded notes (ETNs), eclipsed the assets held by hedge funds.

“According to our analysis there was US$2.971 trillion invested in the 5,823 ETFs/ETPs listed globally at the end of Q2 2015, assets were down slightly from their record high of US$3.015 trillion at the end of May 2015, while assets in the global hedge fund industry, according to a new report published by Hedge Fund Research HFR, reached a new record high of US$2.969 trillion invested in 8,497 hedge funds, which is US$2 billion smaller than the assets in the global ETF/ETP industry,” said ETFGI two months ago.

Well, hedge funds are a big reason why ETFs are growing, but while hedge funds are among the wide range of institutional investors increasing ETF usage, their ETF selections are pretty bland. For example, the SPDR S&P 500 ETF SPY, the world's largest ETF, is the ETF most widely held by hedge funds.

“As of mid-August disclosures, SPY was the most widely held ETF, with 99 hedge funds having exposure. This is not surprising to us as this is the largest and oldest ETF with $161 billion in assets. More than 200 million shares trade on a daily basis with $0.01 bid/ask spread. We think SPY is the preferred way of getting exposure to the S&P 500 index and is often used as a place to park assets while transitioning to other investments,” according to a new research note by S&P Capital IQ. 

The SPDR Gold Shares GLD, the world's largest ETF backed by physical holdings of gold, was the second-most popular ETF among hedge funds with 49 hedge funds showing a stake in the ETF as of mid-August, according to S&P Capital IQ.

That includes John Paulson's eponymous Paulson & Co. Pauslon & Co. was once the largest GLD shareholder, but the hedge fund trimmed its stake in the gold ETF during the second quarter. Other broad market ETFs popular among the hedge fund crowd include the iShares Russell 2000 ETF IWM and the Vanguard FTSE Emerging Markets ETF VWO. VWO, the largest emerging markets ETF by assets, is one of the largest equity holding at Ray Dalio's Bridgewater Associates.

Hedge funds are also big users of sector ETFs, including the Health Care Select Sector SPDR XLV and the Utilities Select Sector SPDR XLU. 

“Looking deeper into ETFs that are widely held, we find a number of sector and industry focused ETFs. Health Care Select Sector SPDR (XLV) and Utilities Select Sector SPDR (XLU) were held by 32 and 29 hedge funds, respectively. We think investors have used sector ETFs to overweight their portfolios relative to the S&P 500 index. However, while XLV experienced $2.3 billion in new assets from its broader investor base this year, XLU had $462 million in outflows,” said S&P Capital IQ.

Despite another year of massive inflows to fixed income ETFs, many hedge funds prefer equity ETFs over bond funds.

“There are just 11 fixed income ETFs that trade on average more than 2 million shares on a daily basis compared to 77 equity ETFs. We think institutional investors are more focused on an ETF’s liquidity than other factors we use in our research including expense ratio, technical trends and a holdings review,” said S&P Capital IQ.

The iShares 20+ Year Treasury ETF TLT was the only bond ETF held by the top 20 hedge funds, according to the research firm.