ETFs Gain Greater Traction With Institutions

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

Though ETFs are often thought of as passive investments, many of the institutional investors Greenwich surveyed said they now use them to gain active exposure to domestic and international equities.

The study, sponsored by BlackRock, found 60 percent of asset managers 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.

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.

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.

Blackrock’s Tennican said there has been a snowball effect in terms of the popularity of ETFs: As more investors use them, the more liquidity they have, and consequently, more institutions take notice.

"It’s an exciting trend that we’re seeing in terms of the institutional usage," Tennican said. "Clearly we’re out there speaking with people everyday, so we feel it anecdotally, but it’s nice to see third-party vendors like Greenwich going out and doing research that validates what we’re seeing in the field."

Tom Smykowski, managing director and head of ConvergEx’s global portfolio and ETF desk, said while the findings of the report were not particularly surprising, this was the first time he had seen the recent shift by institutional investors quantified.

Smykowski said managers are now creating portfolios of ETFs to use as baskets rather than just as single-point exposures. He expects institutional use of the instruments to double, perhaps as soon as by the year’s end.

Traders are going to have to modify their systems to specifically handle ETFs, according to Smykowski. That’s because trading technology will have to utilize underlying exposures as opposed to just looking at point-to-point beta exposure, he said.

"The technology on the desktops of all these traders needs to be adjusted to handle these product lines as a separate subset of the equity business," Smykowski said.

Because of the popularity of ETFs, ConvergEx has already made adjustments to handle these instruments, and Smykowski said he has seen some competitors do the same.