The buyside likes exchange traded funds despite last Augusts ETF market meltdown. And one consultancy said there are five drivers behind traders affinity for the instruments.
Institutional investment in exchange-traded funds is growing due in large part to the versatility of the funds, which U.S. institutions are incorporating into an expanding range of portfolio functions and asset classes, according to market consultancy Greenwich Associates. In 2015, Greenwich found that total ETF allocations as some institutions adopted ETFs in their portfolios for the first time, and existing users found new applications for the funds.
In its most recent ETF study, Institutional Investment in ETFs: Versatility Fuels Growth, Greenwich Associates said the trend towards increased usage is expected to continue. An analysis of the latest results reveals five primary drivers:
1. Existing institutional users are finding new applications for ETFs in their portfolios, and growing numbers are using ETFs as a primary vehicle to implement long-term strategies. Sixty-eight percent of institutional ETF assets are now categorized as strategic in nature-a share that has climbed from just 58% in 2013 and 63% in 2014.
2. ETFs are taking on a larger and more important role in institutional fixed-income portfolios. Liquidity issues have led many institutions to adopt fixed-income ETFs, as ETF liquidity has increased dramatically in recent years. Sixty-five percent of institutional ETF users in the study employ ETFs in fixed income.
3. Institutions are using ETFs alongside derivatives. More than half the institutions in this years study replaced derivative products, such as equity futures contracts, with ETFs in the last year, and 78% of futures users plan to replace an existing futures position with an ETF in the next 12 months.
4. Innovative ETF strategies and approaches are gaining traction among institutions. Approximately 30% of institutions are employing smart beta (non-market cap weighted) ETFs, and an equal percentage are using currency-hedged ETFs. At the same time, asset managers offering increasingly popular multi-asset-class funds are using ETFs to fully implement strategies or scale their products.
5. Insurance companies are adopting ETFs as a means of investing both surplus and reserve assets. As recently as 2013 only 30% of insurance companies used ETFs to invest surplus assets, and only 6% used ETFs to invest reserve assets. This year, 59% of insurers in the study are using ETFs for surplus assets and 71% are using ETFs to invest reserve assets, higher than expectations.
As these five developments demonstrate, ETFs are taking on a much more important and strategic role in institutional portfolios, said Greenwich Associates consultant Andrew McCollum. As a result, institutions are now adopting a more careful and discerning approach to selecting ETFs to achieve strategic investment exposures.
