No two investors will employ the same trading strategy, investment horizon, or earn the same yield on cash deposits. Even for similar investment scenarios, there may be multiple — and occasionally conflicting — considerations. No matter the scenario, the full set of index-tracking vehicles should be considered to help determine the optimal instrument.
Index futures and ETFs each have a role in institutional index allocations — though often at different times and for different purposes. Establishing a consistent framework to compare each instrument, as well as an internal process to assign ownership of such decisions, is increasingly necessary.
The trouble with these comparisons is there is no single conclusion to draw: the most liquid ETF may also be the most expensive, the lowest cost ETF may not track the preferred index, and the one that has tracked best in the past may not do so in the future. For example, the largest MSCI Emerging Markets ETF by assets is the iShares Core MSCI Emerging Markets ETF1 (IEMG), while the most liquid is the iShares MSCI Emerging Markets ETF2 (EEM).Similarly, MSCI Emerging Markets Futures contract, which is listed on the International Exchange (ICE), boasts the highest daily volume of any MSCI emerging market index product — but also has the highest volatility of carry costs of any product.3
In practice, such comparisons are not “out of the box,” but require a level of customization that increases with the size and complexity of the exposure. Specifying a target benchmark is the first step in comparing ETFs and derivatives. ETFs can provide targeted exposure to a wide variety of indexes, while futures’ open interest tends to be concentrated in a handful of local indexes.
For institutional investors with an MSCI benchmark – and that is certainly a large cohort — futures can introduce significant tracking error. Most futures contracts do not track MSCI indexes — in fact, only 14% of global futures by open interest, according to BlackRock and Bloomberg data (as of 9/30/19). Many investors will find using non-MSCI futures may introduce basis risk to an index replication strategy that more than offsets the higher liquidity they might enjoy.
So, what is the best way to compare ETFs and futures? Find out here.
1 Bloomberg as of 10/31/19, based on prior 1-year average daily volume.
2 Bloomberg as of 10/31/19, based on prior 1-year average daily volume.
3 Bloomberg as of 10/31/19, based on prior 1-year average daily volume.
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International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks often are heightened for investments in emerging/developing markets and in concentrations of single countries.
The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective. Investment comparisons are for illustrative purposes only. To better understand the similarities and differences between investments, including investment objectives, risks, fees and expenses, it is important to read the products' prospectuses.
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