U.S. institutions plan to increase their use of ETFs in 2016 according to a new report, Institutional Investment in ETFs: Versatility Fuels Growth from Greenwich Associates. The study, which is in its fifth year and sponsored by BlackRock, found that institutions are increasingly using ETFs for longer-term, strategic allocations as well as cost-effective replacements for bonds and derivatives.
U.S. institutions currently represent approximately 36%, or $756bn of the total $2.1tn in U.S. ETF assets.1 Between August and November 2015, Greenwich Associates interviewed 183 U.S. institutional investors about their use and perceptions of ETFs. This included 41 asset managers, 51 institutional funds (pensions, endowments and foundations), 47 RIAs, 24 insurance companies and 20 investment consultants.
All of the ETF users in the study invested in equity ETFs, with 36% planning to increase allocations in the year ahead and 35% of those planning to boost allocations by 10% or more. 35% of fixed income ETF users expect to increase allocations this year, and 36% plan to do so by 10% or more.
Greenwich Associates found that approximately 43% of institutional users invest 10% or more of their overall portfolio in ETFs. Nearly 20% of non-ETF users are considering adding ETFs to their portfolios in the next year.
Matching the exposure needed was the most important factor when selecting an ETF as mentioned by 82% of interviewed investors. Other factors considered when selecting an ETF included liquidity/trading volume (76%), expense ratio (72%) and tracking error of the fund (68%).
Greenwich Associates identified five key trends driving ETF growth in the U.S. institutional market:
Existing institutional users are finding new applications for ETFs in their portfolios, and a growing number are using ETFs as a primary vehicle to implement long-term strategies: 68% of institutional ETF assets are now categorized as “strategic” in nature—a share that has climbed from 58% in 2013 and 63% in 2014. The most popular application for ETFs within institutional portfolios is obtaining core exposures—undoubtedly a strategic function.
Fixed income ETF use is expanding: 65% percent of institutional ETF users employ the funds in fixed income. Liquidity levels in traditional fixed income markets have declined over the past several years, creating serious portfolio challenges for investors. Liquidity issues have led many institutions to adopt fixed income ETFs, as ETF liquidity has increased dramatically over the same period. In 2015, institutions name liquidity as an important reason for investing in bond ETFs.
Institutions are using ETFs alongside derivatives: ETFs are increasingly being evaluated along with derivatives to determine the best tool to hedge or gain market exposure. More than half the institutions in this year’s 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.
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. ETFs now make up 48% of assets in multi-asset portfolios, according to asset managers running these funds.
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.
Daniel Gamba, Head of iShares U.S. institutional Business at BlackRock commented:
“U.S. institutions are contributing to the relentless growth of the ETF industry as they take advantage of the potential benefits and applications of ETFs. Institutions are using ETFs to seek additional liquidity in their bond portfolios, to aim to outperform broad market returns via smart beta strategies and to make longer-term strategic allocations. Some investors are also reducing their portfolio costs by replacing futures with ETFs.”
“We expect 2016 will be another record year for the ETF industry, and we look forward to working with our clients as they use ETFs to help achieve their goals.”