An article in the Financial Times raises the issue of smaller corporates finding it harder to raise capital through exchange traded funds, which have seen huge growth in the past decade – but have mainly benefited bigger corporates.

Exchange traded funds (ETFs) – collections of securities packaged into a fund – have seen huge growth in the past decade and now account for nearly one-half of all trading in US company stocks.

These funds, which are attracting investors away from other types of investment fund (such as mutual funds) now have more than $3 trillion of assets under management (although this is still a small percentage – less than 5 per cent – of the total investment universe). The biggest ETFs are run by BlackRock, Vanguard and State Street – the latter's SPDR S&P 500 is the biggest, trading more than $14bn each day. The graph below shows global growth in ETFs since 2003.

Smaller corporates missing out

The benefits of trading in ETFs are obvious for investors: they can trade at any time of the trading day, with lower costs and with some tax benefits. But for some corporates, there are downsides. According to the Financial Times, ETFs have greater sensitivity to corporate announcements, but this has favoured the bigger corporates. The newspaper explains that it can be harder for smaller companies to raise capital: “Investors moving money through ETFs tend to put capital into the biggest companies with the biggest weight in the index. Others go without.” This is a problem particularly in emerging markets, where state-owned companies tend to receive more ETF investment and smaller companies find it harder to raise capital.

There is also concern about the high turnover in company stock. For ETFs, turnover can be as high as 880 per cent in a year, while for typical stocks this would be around 12 per cent. This rapid stock trading could potentially cause systemic problems.

Systemic risks

There are also concerns that ETFs could cause systemic financial risks because the securities that are packaged in the ETF may be less liquid than the ETF itself. Mark Dampier, of Hargreaves Lansdown, told the FT: “This is something regulators might like to look at.”

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CTMfile take: the Financial Times article suggests that private equity groups could be the answer to providing capital to smaller companies.