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July 1, 2011

Stock Pickers Pick ETFs

By James Armstrong

The recent boom in exchange traded funds is likely to continue, as institutional investors are finding new uses for the instruments, according to a recent report from Greenwich Associates.

ETFs are often thought of as passive investments, but many institutions Greenwich surveyed said they now use them for active exposure to domestic and international equities. The study, sponsored by BlackRock, found 60 percent of investors use ETFs to add alpha through tactical application. "Over the past couple of years, we've seen increasing interest in using them in a more tactical, active fashion," said Liz Tennican, head of institutional sales at BlackRock's iShares.

Liz Tennican

Tennican said when ETFs were first launched they were thought of as institutional vehicles. Over the years, there has been tremendous growth in the use of ETFs by retail investors, she said, but now institutional use of the vehicles is picking up again.

Most institutions use ETFs for cash equitization, manager transitions, rebalancing and making tactical adjustments to portfolios, according to the Greenwich study. However, the survey found a growing number of institutions are also using ETFs for liquidity management.

ETFs can be a cost-effective way for institutional investors to capture beta exposure, while still maintaining the liquidity they need to meet redemption and contribution requests, Tennican said.

The Greenwich study was based on interviews with 45 institutional funds and 25 large asset management firms in the U.S. As a group, the surveyed institutions manage about $7.5 trillion.

Nearly half of the asset management firms surveyed said they plan to increase their investments in ETFs over the next two years, while not a single asset manager said it plans to cut back on ETF allocations in the near future.

Managers of institutional funds-including pensions, endowments and foundations-were also bullish on ETFs. Only 9 percent of those surveyed planned to cut back on ETF allocations in the next two years while 32 percent foresaw increasing their allocations.

The combined assets of the nation's ETFs recently topped $1.1 trillion, according to the Investment Company Institute.

Laura Morrison, head of U.S. exchange traded products for NYSE Euronext, said the number of ETFs available is increasing rapidly.

Currently, there are more than a thousand ETFs trading in the U.S. Year-to-date, NYSE Euronext has so far had 107 new listings of ETFs in the U.S., compared with 63 for the same period last year and 25 over that period in 2009.

As more ETFs become available, institutions can use them for more purposes. According to Morrison, much of the growth in institutional use of the instruments is driven by the efforts of issuers.

"What we're seeing is the issuers have been very focused on education, so that new institutional traders that have not been involved in ETFs are now engaging more than they were before," Morrison said. Institutional traders are finding that ETFs are a quick way to gain broad exposure to the market in an efficient, low-cost way, she added.

Tom Smykowski, who heads ConvergEx's global portfolio and ETF desk, said the report was not surprising. But this was the first time he had seen institutional ETF appetite documented. He said managers are now creating portfolios of ETFs to use as baskets rather than just as single-point exposures. He expects institutional use to double, perhaps as soon as by the year's end.


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