Institutional Investors' Relationship With ETFs Deepens

Stamford, CT - 6 May 2013

Institutions Using ETFs Plan to Increase Assets Dedicated to the Products

Half of institutions using exchange-traded funds (ETFs) expect to increase their allocations to ETFs in the coming year according to the results of new study, Institutional Investors’ Relationship with ETFs Deepens, from Greenwich Associates. When looking to invest in ETFs, U.S. institutions turn most often to iShares, BlackRock’s ETF business.

Last year’s study on ETF usage, Institutions Find New, Increasingly Strategic Uses for ETFs, indicated that institutional investors with experience using ETFs for tactical portfolio adjustments were finding new, more strategic and longer-term uses for the funds. The success achieved by these early adopters using ETFs to implement investment strategies in a growing range of asset classes has begun to attract the attention of their institutional peers.

This annual study, in its fourth year, was conducted by Greenwich Associates and sponsored by iShares. The results are based on interviews with 179 institutional funds interviewed between February and April 2013 and include corporate pensions, public pensions, foundations and endowments, and large asset management firms. For the first time this year, investment consultants, insurance companies and registered investment advisors (RIAs) were also interviewed.

In the United States, 18% of institutional investors now employ ETFs in their portfolios, up from 14% in 2012. Usage is significantly higher among certain types of institutions, especially among the largest and most innovative institutional investors. For example, 47% of U.S. endowments use ETFs, as do nearly a quarter of corporate and public pension funds with more than $5 billion in assets under management. Nine out of 10 of these current ETF users expect their level of ETF investment to remain stable or increase in the coming year. At least 40% of investment consultants, insurance companies and RIAs that now use ETFs expect to increase their usage of these products by year end.

Increased ETF Usage in Fixed Income, Commodities and Real Estate

Nearly 90% of institutions that use ETFs employ them in domestic equities and 74% use them in international equity portfolios. ETFs are also gaining traction in fixed income, where 55% of institutional ETF users invest in domestic fixed-income ETFs. As one would expect, usage of domestic fixed income is most common among insurance companies at 78%. Interestingly, 74% of RIAs also employ ETFs in domestic fixed income.

“Decreased fixed-income bond liquidity has driven institutional investors to explore new ways to access fixed-income markets,” says Matthew Tucker, Head of iShares Fixed-Income Investment Strategy at BlackRock. “Fixed-income ETFs are increasingly being used by investors to access liquidity and implement investment strategies.”

“These results clearly demonstrate that the role of ETFs within institutional portfolios is changing,” says Greenwich Associates consultant Andrew McCollum. “Although ETFs first entered institutional portfolios mainly as tactical tools and continue to be used in important tactical functions, many institutions now regularly use ETFs as tools for gaining long-term exposures and implementing core investment strategies.”

One Tool, Many Applications

While institutional investors continue to find several ways to use ETFs to satisfy investment strategy needs, investors’ need for passive exposures as part of core/satellite portfolio models has emerged as a key driver of ETF demand among institutions. In fact, institutions participating in the study cited “passive exposure in the core” as the most common ETF application. A majority of insurance companies (72%) and pensions, foundations and endowments (67%) employ ETFs as a passive component of their “core” portfolios. Some of these institutional investors likely keep ETFs in their core holdings as part of a longer-term strategy, while others may find it useful to employ ETFs for tactical shifts within their core exposures.

ETFs also remain effective tools for tactical portfolio functions — 70% of institutional ETF users employ ETFs for tactical portfolio adjustments, up sharply from 48% in 2012.

What Do Institutions Look for in an ETF?

Institutional investors view liquidity/trading volume as their top priority when it comes to selecting or recommending a specific ETF with 76% including liquidity/trading volume among the three most important criteria used in picking an ETF. Also ranked among the most important factors considered in selecting an ETF are the fund expense ratio (cited by 68%) and tracking error (cited by 49%).

iShares Leads Institutional ETF Market

These selection criteria help explain BlackRock’s dominant position in the institutional ETF marketplace. iShares is by far the most commonly used ETF provider among institutions. Among ETF users, approximately nine out of 10 purchase these products from iShares, including every one of the RIAs participating in the study, 95% of insurance companies and 90% of asset managers. Second in terms of institutional usage is Vanguard, followed by SPDRs/State Street and PowerShares.

Among these leading ETF providers, Vanguard is cited most frequently as providing good value. iShares is cited by institutions most often for providing the industry’s most liquid products, the best range of products, the strongest index tracking, the strongest service platform, and for being the overall “safest choice” for an ETF provider.

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