How are hedge fund managers using ETFs?

Fact: they're the 3rd largest institutional ETF user.

April 10, 2012

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stock_images_chartLast week, ETF provider Global X announced it was getting ready to launch four new hedge fund ETFs, including one called the Global X Top Hedge fund Equity Holdings ETF and another called the Global X Listed Hedge funds ETF.

The thing is, a lot of hedge funds already use ETFs – hedge fund managers are the third largest institutional ETF investors according to Pensions & Investments. But you won’t hear many hedge fund managers talking about ETFs – in fact, most keep their ETF use on the down low, since hedge fund fees are higher and ETFs are notoriously cheap.

But ETFs are becoming useful tools for active managers of every stripe so it’s no surprise they’re being tapped by hedge funds too. According to Pensions & Investments, hedge fund managers are using ETFs as a traditional hedge, for shorting sectors and also for gaining long exposure.

ETFs are also being used for quick access to opportunities, acting as a kind of placeholder while individual securities are selected. They also help managers invest in markets where the hedge fund doesn’t have infrastructure or specific knowledge of how those markets function. And they’re also being used to arbitrage securities – something hedge funds do a lot of.

As the ETF space grows and individual ETFs become even larger, the opportunities for hedge fund use will grow exponentially. The bigger the ETF the easier it is for hedge funds to move in and out unseen – it also makes them more liquid. In the end, bigger is better for managers in the hedge fund space.

As ETFs become more entrenched among hedge fund managers (and in overall active management) I think there will be less of a stigma attached to using them and more discussion of their potential uses. For now, however, star hedge fund managers continue to be quiet about the role they play.

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