Institutional Demand for ETFs Increasing

Institutional investors are increasingly bullish on using exchange-traded funds (ETFs) in their portfolios, according to a new study.

Forty-eight percent of asset management firms interviewed for the Greenwich Associates study expect to increase portfolio allocations to ETFs between now and 2013. Of those, slightly more than half expect to increase ETF allocations by 5% or more. Among institutional funds, approximately one-third of study participants expect to increase ETF allocations by 2013. Those institutional funds were about evenly divided with roughly half planning to increase allocations by 1- 4% and half planning increases of 5% or more.   

“Perhaps even more telling than those findings is the fact that not a single asset manager reported plans to cut ETF allocations in the coming two years, and less than one in 10 institutional funds plan to reduce allocations to ETFs in that period,” said Greenwich Associates consultant Andrew McCollum.

Liquidity is the most important factor for both asset managers and institutional funds when it comes to selecting an ETF provider, the study found. After liquidity, institutional funds focus on providers’ expense ratios and tracking errors, followed by the strength and reputation of the fund company behind the funds, as well as the track record of the fund itself. Asset managers focus on many of the same factors when picking an ETF provider. However, asset managers place less of an emphasis on the track record of the specific fund and pay more attention to the benchmarks used by competing providers in their funds.  

A few very large providers dominate the institutional market. Chief among them is iShares/BlackRock, with 85% of participating asset managers and 78% of participating institutional funds obtaining ETFs from the firm. Among asset managers, 55% of participants use SPDRs/State Street, 45% use Vanguard, and 35% use BLDRs/Powershares/INVESCO. Among institutional funds, 44% use SPDRs/State Street, 29% use Vanguard, and 7% use BLDRs/Powershares/INVESCO.

ETF Uses  

Though conventional thinking may be that ETFs only provide passive exposure, many respondents to a new Greenwich Associates study of current institutional ETF users view their ETF investments as “active” exposures. Among asset managers, 53% say that ETFs are used to gain active exposure to international equities, and 43% use ETFs for active exposure to domestic equities. These respondents are not necessarily using actively managed ETFs, but rather use passive ETFs to gain a tactical active exposure. Institutional funds are slightly less likely to view ETFs in this way, with 23% and 15% using ETFs to gain a tactical active exposure to domestic and international equities, respectively.  

Institutions participating in the study use ETFs for four main functions: cash equitization, manager transitions, rebalancing, and making tactical adjustments to portfolios. Notably, 75% of asset managers in the study use ETFs for gaining rapid exposure to an asset class (i.e., cash equitization), and 63% of institutional fund respondents use ETFs during the transition management process. In addition to the four main ETF uses, approximately 30% of participating asset managers use ETFs for hedging and 20% use them for portfolio completion. 

A small, but growing group of investors also utilize ETFs as a liquidity sleeve in their portfolios. In fact, 10% of institutional funds and asset managers note using ETFs for this purpose.   

“The marked increase in the use of ETFs for liquidity management is a significant development, reflecting sharper focus by institutions to assert control over their operational abilities during periods of irregular market conditions,” said Liz Tennican, Head of U.S. iShares Institutional at BlackRock.  

The study, which is in its second year, was conducted by Greenwich Associates and sponsored by BlackRock. The results are based on interviews with 45 institutional funds — including corporate pensions, public pensions, and endowments and foundations — and 25 large asset management firms in the United States. As a group, these institutions manage approximately $7.5 trillion.