Volatility and Usage Drive Buy-Side into ETFs

U.S. institutional investors are the global leaders when it comes to exchange-traded fund (ETF) investing.

Institutional investments in ETFs increased significantly in the United States in 2018. Average allocations by institutions currently investing in ETFs jumped to 24.8% of total assets, up from 18.5% in 2017, among the 181 institutional ETF investors participating in the Greenwich Associates 2018 U.S. Exchange-Traded Funds Study. This percentage tops allocations among institutions in Canada, Europe, Asia, and Latin America.

In the U.S., we saw a significant pick-up last year in institutional use of ETFs as investors readjusted their portfolios for resiliency in the face of market volatility, says Greenwich Associates Managing Director Andrew McCollum and author of ETFs: U.S. Institutions New Tool of Choice for Portfolio Construction.

Last years strong growth was actually driven in large part by three powerful trends affecting institutional portfolios and portfolio construction:

  1. Turbulence Drives Demand: A confluence of events ranging from interest-rate hikes and fears of recession, to trade wars and Brexit had institutions laser-focused on risk management in 2018. As they repositioned their portfolios to address these risks, many U.S. institutions used ETFs to implement specific changes. Study participants say they chose ETFs for an ease of use that allowed them to quickly and seamlessly integrate new exposures into strategies across portfolios and asset classes, and to take advantage of other characteristics such as speed of execution, single-trade diversification and liquidity.
  1. The Index Revolution Proceeds: U.S. institutions continued shifting assets from active management to index strategies, and 78% of study participants name ETFs as their preferred vehicle for index exposures. As ETFs displace other investment vehicles in institutional portfolios, active mutual funds are by far the most common vehicles being replaced. This transition should fuel additional demand for ETFs as institutions continue shifting assets to index strategies.
  1. Proliferation Across Portfolios: Institutional investors continue expanding the list of portfolio functions in which they are applying ETFs. The spread of ETFs is being fueled in large part by versatility that allows them to serve a broad range of strategic and tactical purposes, and by their role as institutions preferred vehicle for factor-based/smart beta and other specialized exposures. Going forward, institutions integration of ESG principles into their portfolios and investment processes could give a further boost to ETF demand.

Although its unclear if ETFs can sustain last years rapid pace of expansion, we expect the growing list of uses and overall assets invested to continue to grow in 2019, as more than 40% of equity and bond ETF investors in the study plan to increase ETF allocations in the year ahead, says Andrew McCollum.