BlackRock's Fuhr: ETF Embrace Among Institutional Investors Leads Regulators to Enhance Scrutiny

(April 27, 2011) — BlackRock’s Deborah Fuhr is witnessing heightened scrutiny of exchange-traded products due to ballooning interest among institutional investors.

“Exchange-traded funds (ETFs) have grown very quickly relative to other products, especially outside the United States, which has driven the analysis that has been undertaken by regulators,” Fuhr told aiCIO, referring to recent warnings over the increasing complexity of exchange-traded products by the Financial Stability Board, the International Monetary Fund, and the Board of International Settlements. “ETFs have risen in popularity within the retail and institutional sectors, so I think the concern is to make sure regulators understand the products that have been growing and evolving very quickly.”

According to Fuhr, the legacy of Lehman Brothers’ bankruptcy and of the financial crisis more broadly was that regulators need to take a closer look at the unexpected. “Any product that has grown significantly is important,” she said, noting that while it took mutual funds roughly 66 years to break through $1 trillion in the United States, the growth in ETF assets in the US reached $1 trillion in only 18 years.

Tracing the appeal of ETFs in recent months, Fuhr explained that volatility in global markets — with events in the Middle East, North Africa, and Japan in particular — has led to ballooning interest in ETFs. “In February, turbulence in the Middle East drove up oil and energy in the short run,” she said, noting that investors have been consequently looking to commodities as an inflation hedge. “Investors have used ETFs to quickly adjust to things that are happening in the market,” she said.

In response to claims from investment consultants that institutional investors — which tend to be long-term and strategic in nature — generally do not need the intraday liquidity that ETFs offer, Fuhr noted that while these investment vehicles are not always the right product, pensions are increasingly using ETFs for their flexibility to quickly implement exposure in the midst of rapidly changing market conditions.

Despite the embrace of ETFs as an investment vehicle of choice for a growing number of institutional investors, Fuhr cautioned that pensions need to do their homework. “They must understand their exposure, the structure of the product, the assets in the fund, and the reputation of the firm behind the product,” she said.