Despite great predictions for the ETF market, growth of the low-cost index-based investment vehicles has slowed among retail investors and still has not caught on in with institutions.

The average monthly value of exchange-traded funds (ETFs) traded on the ASX fell below $500 million in the 12 months to May 31, and now stands at levels close to those of two years ago, according to the latest data from the ASX.

Even though the 12-month average number of trades increased from about 15,000 to 16,000 a month, the value of those trades declined from $590 million to $490 million, a fall of almost 17 per cent.

In the year to May 31, 2010, the average monthly value of ETFs traded stood at $498 million.

Amanda Skelly, director of ETFs at Russell Investments, says the state of equity markets has affected ETF growth, but institutional investors still have a general view that ETFs are designed for retail investors.

Skelly says most money invested in Russell’s ETFs is from self-managed superannuation funds.

“I have a theory that we saw a huge growth in ETFs a couple of years ago because you had your early adopters jumping on board; they’d done their research and they knew what they were doing,” she says.

“And then it stopped. Now we’re waiting for the next wave – more of the masses to get comfortable with ETFs. That’s my view. Yes, markets have been yucky, but it’s this next level of investors that we’re trying to educate.”

How to effectively use ETFs

However, institutional investors can use ETFs effectively, says David Hartley, chief investment officer for Sunsuper.

About two years ago, Sunsuper invested approximately $200 million in an emerging-market ETF as the first step in gaining exposure to those markets. It has now wound back that position substantially, after establishing a line-up of emerging-market managers.

On one hand, Hartley says, ETFs provide some significant potential benefits, such as being able to gain broad market exposure quickly, particularly where “it can take you a while to get organised”, such as in emerging markets.

“Also, you can change your exposure fairly quickly,” Hartley says. “You can use it as a temporary holding vehicle, too.”

ETFs can be used effectively to achieve country or sector tilts, Hartley says, but superannuation funds need to consider carefully what ETFs bring to the table.

They can be more expensive in the long run than other investment approaches. For example, he says Sunsuper has negotiated a passive Australian-equity mandate at a lower cost than using ETFs in the same market.

Using ETFs to gain exposure has some advantages over using futures, he says. There are tracking error issues with futures, which ETFs can avoid, as long as they are fairly priced.

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