Institutional investors turn to ETFs for versatility

A look at their behaviour last year shows some creative ways institutions are using ETFs

Institutional investors turn to ETFs for versatility

The recent eighth edition of the Greenwich Associates US ETF Study has found that institutions are getting more familiar with ETFs. With that increased familiarity, institutional investors are becoming more comfortable in purchasing and using ETF products in creative ways.

Despite the rush to lower prices among ETF issuers, only 66% of respondents in the Greenwich survey included it among their fund selection criteria. “For 80% of institutions surveyed, the top concern … was whether that fund's particular exposure met their portfolio needs,” reported Other primary concerns included liquidity and volume (76%); fund performance, which included tracking error (66%); and the fund firm and management behind a fund (53%).

“[G]iven that ETF fees are so low, the differential between providers is not as substantial as it is among active managers,” explained Andrew McCollum, managing director of Greenwich Associates and author of the report.

The way ETFs are replacing active mutual funds has been the biggest story in recent years, but the low-cost funds are also increasingly using them in lieu of individual stocks, bonds, and even futures. Among the respondents who use futures for their beta exposure, nearly half said they’d swapped out derivatives with ETFs in the past year, and 60% said they were considering doing it.

“Often, futures contracts aren't just 5-10% more expensive [than ETFs],” said Ravi Goutam, head of Pensions, Foundations and Endowments for iShares. “[T]hey end up being 5-10 times more expensive.”

Factor investing is also gathering pace in the institutional space, with 44% of participants reportedly using non-market-cap-weighted or smart-beta strategies in 2017 — up 7% year-on-year. A big reason for that is a growing concern about market volatility, illustrated by the adoption of minimum-volatility ETFs by 62% of institutions that use smart-beta strategies. Multifactor strategies were also slightly more popular (53%) than single-factor products (50%).

Last year also saw an increase in institutions’ bond-ETF allocations across nearly every category, with international investment-grade funds being the only one to remain flat year-over-year. According to McCollum, fixed-income ETF adoption had been on a slow burn for years; investors’ comfort with the products, coupled with rising interest rates and a continuing liquidity crunch in the bond market, took the trend to an inflection point in 2017.

But while US institutional investors were generally more comfortable with ETFs, they seemed to have persistent doubts regarding ESG investments. While 43% of European institutions that “believe” ESG investing leads to strong long-term returns, only 8% of US institutions held that conviction.

“ESG ETFs have actually seen significant outperformance recently, particularly in 2017,” said. “Yet only 15% of U.S. investors have sold out of certain strategies or invested in new ones as a result of ESG considerations, compared with about half of European investors.”


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