Executive summary:
- The cost to roll futures has risen significantly over the past two years due to strong market performance and supply/demand.
- We see futures as a valuable tool when used for the right purposes—such as in a liquidity overlay capacity and when capital efficiency is needed, such as in an unfunded exposure. However, we believe that investors looking to maintain asset-class exposures for longer periods of time might want to consider using ETFs or physicals instead.
- Some of the advantages of ETFs include minimal tracking error to an index, strong liquidity, advantageous tax implications, and cheaper rolling costs than futures when held for longer periods of time.
- Some of the advantages of physicals include low holding costs and customizability. While they tend to be the most expensive to trade in the short-term, the low holding costs quickly make up for the initial transaction cost. Physicals are typically a great option for investors that expect to hold a position for several months (or more) with modest levels of turnover.
In mid-2023, the estimated costs to roll S&P 500 futures on a quarterly cycle was roughly 0.40%, or 40 basis points (bps) annualized—a fairly justifiable expense for most investors considering the benefits of the instrument.
Fast forward two years later to early 2025, and now the 1-year average roll cost has steadily increased to an estimated +95 bps on an annualized basis. This means the “cost” to hold long exposure has more than doubled in the past two years. It’s important to note that these roll costs are not an explicit transaction cost like a commission, but rather can be considered the implied cost of financing. The implied financing costs are always present and baked into futures pricing, but only explicitly measurable during the roll periods.
For some investors looking to gain market exposure through various instruments, the increases in futures costs have caused them to consider alternative solutions. So, what should they do? Move to ETFs (exchange-traded funds)? Pivot to physicals?
The answer, like so much in investing, strongly hinges on what the investor is trying to accomplish.
With this in mind, let’s dig into the pros and cons of using the three main implementation instruments—futures, ETFs, and physicals—to gain market exposure.
Futures: Highly liquid, but can be costly to roll in strong markets
Derivatives tend to be one of the more common instrument options used by investors to gain market exposure—specifically, listed futures contracts, such as S&P 500 futures. And the reasons are plenty: they’re the cheapest to trade, they’re capital-efficient, they have trading flexibility (they can be traded after-hours), and they’re the most liquid.
The dramatic cost increase in rolling futures over the past two years, however, has put a significant damper on their appeal. Roll costs for major equity indexes across the globe have risen quite substantially over the last two years, with many of the experiencing roll costs 2-3x that of their 3-year average.
What’s fueling the sharp increase? Broadly speaking, the rise can be attributed to two factors: robust market performance and supply/demand. Simply put, when markets are strong, demand for long exposure tends to increase and futures costs go up, as dealers only have so much balance-sheet capacity. When markets sell off, demand drops, and brokers in turn have more capacity on their balance sheets, which translates to lower roll costs on futures contracts.
It’s also important to note that historically, roll costs between December and March tend to be at a premium due to year-end balance-sheet constraints. This is consistent with the December 2024/March 2025 roll period being by far the most expensive measurement period of last year.
Now, this isn’t to say we think investors should shy away from using futures because of their increased roll costs. We see futures as a valuable tool when used for the right purposes—such as in a liquidity overlay capacity and when capital efficiency is needed, such as in an unfunded exposure. However, we believe that investors looking to maintain asset-class exposures for longer periods of time would be well-served to consider using ETFs or physicals instead. Let’s dig in and see why.
ETFs: Minimal tracking error and cheaper to roll than futures
For some investors, ETFs can be a better alternative to futures. Some of their advantages include minimal tracking error to an index, strong liquidity, advantageous tax implications, and cheaper transaction costs than futures when held for longer periods of time. Because of this, using ETFs to gain exposure can result in substantial savings costs for investors—particularly the longer they’re held.
The chart above helps demonstrate this by comparing the holding costs of exposure to the MSCI All-Country World Index across futures, ETFs, and physicals. As shown, futures are cheapest for short-term liquidity needs such as a daily cash equitization overlay, or to offset exposures in a transition management (TM) event. However, as the holding period lengthens, futures become the least appropriate tool, with ETFs and physicals more cost-effective.
Physicals: Cheap to hold, customizable
As the chart shows, while physicals tend to be the most expensive in the short-term to trade (out of the three options), the low holding costs quickly make up for that initial transaction cost, making it the winner over the medium and long term.
Physicals have other advantages as well, including the fact that they can be customized across factor, sector, and stock-level risks, helping clients tailor exposures to meet their objectives. In addition, client-specific exclusions (security restrictions, industry screens, etc.) can be removed in the construction of the portfolio. The customizability and low holdings costs typically make physicals a great option for clients that expect to hold the position for several months (or more) with modest levels of turnover.
Which implementation instrument is right for you? It depends on your objectives
Since each implementation instrument comes with its own unique set of advantages and challenges, how can an investor realistically gauge which one will work best? To circle back to our earlier point, the best way to ascertain this is to unpack what your specific exposure goals are.
For instance, are you looking for short-term exposure to an asset? Long-term? What are your liquidity needs? How cost-conscious are you? Futures, ETFs, and physicals are all important tools when used for certain purposes—but that purpose must be defined first.
While questions like these warrant serious consideration, they’re not necessarily the type that are top-of-mind for large institutional investors. After all, most have a very full plate to begin with. This is where working with the right implementation partner can be highly advantageous.
The value of working with a skilled implementation partner to manage your exposures
It’s no secret that managing portfolio exposures is a complex process that can lead to unnecessary expenses if best practices aren’t followed. But keeping roll costs and holding costs at bay isn’t something many organizations have the time or resources to do. That’s why we believe it’s best, in most instances, for these companies to lean on a trusted consultative implementation services partner to handle these types of tasks.
The right partner will manage all aspects of your portfolio’s exposures, including keeping a vigilant watch on expenses like roll costs and implementation costs. What’s more, they’ll proactively bring these issues to your attention well before they become problematic. They’ll sit down with you to discuss alternatives, because they’ll understand that defaulting to one instrument type can lead to unintended costs and limitations.
Ultimately, we believe having access to a broader implementation platform that allows for the use of multiple instruments to gain market exposure is critical to attaining investment success. Consider partnering with a skilled implementation provider that offers as much.
Disclosures
These views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page. The information, analysis, and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual or entity.
This material is not an offer, solicitation or recommendation to purchase any security.
Forecasting represents predictions of market prices and/or volume patterns utilizing varying analytical data. It is not representative of a projection of the stock market, or of any specific investment.
Nothing contained in this material is intended to constitute legal, tax, securities or investment advice, nor an opinion regarding the appropriateness of any investment. The general information contained in this publication should not be acted upon without obtaining specific legal, tax and investment advice from a licensed professional.
Please remember that all investments carry some level of risk, including the potential loss of principal invested. They do not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns.
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