Head of ETFs at Mackenzie Investments says comfort level is increasing but there remains a knowledge gap
The expanding use of ETF products in the institutional space is a “true validation” of the industry and what it offers investors, according to a leading provider.
In part II of his interview with WP, Michael Cooke, head of ETFs at Mackenzie Investments explained how he believes the increasing comfort with which institutional investors are utilising ETFs, including longer holding periods and more strategic applications, is reinforcing the democratization of investment.
Retail and institutional are now transacting alongside one another in the same pool of assets in the same trust with a similar sense of relevance. It’s mutually beneficial: as institutions understand the nuances more and up their volume, so retail investors feel more secure in holding the investment vehicle.
Cooke highlighted the Bank of Japan as a global example of this validation. The Bank has been using ETFs to implement its own quantitative easing policy in order to stabilize and grow the Japanese economy, and to support asset prices. Well-known Canadian institutions such as OMERS and Ontario Teachers’ Pension Plan also allocate ETFs selectively because of the cost and liquidity benefits.
“They want efficiency and precision in the exposure, and they feel a particular ETF can deliver that for them,” Cooke said. “Overall, the applications are as vast as the number of investor types we have in the marketplace, but certainly when we see large investors committing capital, it is a true validation about the industry and the individual products in it.”
As the quest for alpha gets more challenging given how researched and covered efficient markets like US equities or Canadian fixed income have become, Cooke believes institutions are taking a more granular examination of where they want to spend their alpha budget in order to extract returns above and beyond the benchmark. Typically, that involves less efficient markets.
In years gone by, investors would have opted for Futures or all the constituents in the S&P 500 or the TSX Composite, or even derivatives such as swaps. While an acceptable method to access the index, Cooke cites the evolution of the ETF industry, and the allure of its trading volume, cost and tracking error ability, as reasons why ETFs are displacing these for the institutional investor.
Cooke added: “Institutional ETFs usage 10-15 years ago was very, very tactical – short holding periods were used to express a very short-term view on a particular market or in order to put to work idle cash in a portfolio. But as they've grown in their familiarity and comfort with the ETF market, you are starting to see longer holding periods and more strategic applications, with generally two years being an average holding period for institutional ETFs usage.
“So, in addition to a growing array of solutions that they are using, the types of usage are also evolving alongside that.”
The competitiveness of the Canadian ETF arena is also a boon. The temptation for a taxable institutional investor, such as an asset management firm, to look south of the border for solutions is often negated by withholding taxes involved in owning a US-listed ETF. All things being equal, a US-listed ETF would include a 15% withholding tax bill, which in a high yield asset class that pays 5-6% could mean you leaving 200 basis points of yield on the table.
Despite the upbeat picture painted by Cooke, he admitted there is still a knowledge gap with some institutional investors when it comes to measuring ETF liquidity. Historically, he explained, investors associate liquidity with trading volume and, by extension, the bid offer spread they're paying to buy a security. Going directly into stocks and bonds this way is predicated on them having a finite number of shares outstanding, which can lead to supply-demand imbalances.
Cooke said: “An ETF, however, has an almost infinite ability to create or redeem units in response to changing demand. So even a relatively new ETF with a small AUM base, if it's based on an investable or liquid underlying portfolio of securities, can accommodate very large transactions, even if the ETF assets itself are not very large.
“It's important that investors realize that the true measure of ETF liquidity is not a function of assets under management or trading volume. It is in fact, the liquidity and the ‘investability’ of the underlying basket. And institutional investors will have all kinds of tools with which they can measure what I describe as implied liquidity.”