Institutional assets are flowing into exchange-traded funds
(ETFs) as U.S. institutions integrate ETFs into essential investment functions
ranging from risk management and liquidity enhancement to the generation of
income and yield in a challenging interest-rate environment.
In a new report, “ETFs:
‘Active’ Tools for Institutional Portfolios,” Greenwich Associates
says it interviewed 187 institutional investors and found respondents invest an
average 21.2% of total assets in ETFs—up from the 18.9% of total assets
reported in 2015. Those allocations are likely to grow in 2017. Forty-seven
percent of equity ETF investors and 38% of bond ETF investors expect to
increase their allocations to the funds in the year ahead.
“Although institutions are using ETFs as a means of
obtaining strategic investment exposures, for many institutions, ETFs also have
taken on a central role in critical functions like risk and liquidity
management,” says Greenwich Associates consultant Andrew McCollum.
Approximately half the institutions in the study use ETFs for liquidity
management and nearly the same number employs ETFs in risk management/overlay
The survey found institutional demand for ETFs is fueled by
several powerful trends:
are using ETFs alongside other investment vehicles. Thirty-eight percent
of institutional ETF users are replacing other vehicles in their
portfolios, including active mutual funds and derivatives positions.
are using innovative ETF structures to address challenges in their
portfolios. Growing numbers of institutions are turning to non-market-cap
weighted/Smart Beta funds like Minimum-Volatility ETFs and Dividend/Equity
Income ETFs to help navigate the challenges posed by low interest rates
and increasing market volatility. The share of institutional ETF users
investing in non-market-cap weighted/Smart Beta ETFs increased to 37% in
2016 from 31% in 2015, and 44% of these investors plan to increase their
allocations to the funds in the next year.
for ETFs is being fueled by the roll-out of new multi-asset funds.
Fifty-two percent of asset managers use ETFs as part of multi-asset funds
operated for clients. That share is up sharply from the 35% of asset
managers employing ETFs in these funds in 2015. Within these funds, asset
managers allocate a full 55% of total assets to ETFs.
impediments to institutional use are giving way. Fewer institutions are
expressing concerns about ETF liquidity and expenses. In fact, many
institutions are introducing the funds into their portfolios specifically
to enhance liquidity and reduce costs. Meanwhile, explicit prohibitions or
limitations against ETF investments are becoming less common in both
equities and fixed income. In 2015, nearly one-quarter of non-users said
they were prevented from investing in fixed-income ETFs by internal
investment guideline restrictions. That share fell to 19% in 2016.
When conducting due diligence on a potential ETF investment,
institutions consider four primary factors: the degree to which the ETF matches
their exposure needs, liquidity/trading volume, the expense ratio of the fund
and performance/tracking error. Insurance companies, of course, pay close
attention to an ETF’s National Association of Insurance Commissioners (NAIC)
rating, and institutions across the board also take into account the fund
company and management behind the ETF.