Study: Institutional Investors Seek ETFs

While ETFs encompass a fraction of institutional investor portfolios, a burgeoning number of these institutions plan to up their use of these investing instruments in the future.

(May 24, 2011) — A new Greenwich Associates study reveals that institutional investors are increasingly bullish on using exchange-traded funds (ETFs) in their portfolios.

“Perhaps even more telling than those findings is the fact that not a single asset manager reported plans to cut ETF allocations in the coming two years, and less than one in 10 institutional funds plan to reduce allocations to ETFs in that period,” says Greenwich Associates consultant Andrew McCollum.

According to the firm, nearly one-half of the asset management firms and one-third of the institutional funds taking part in the Greenwich Associates study of current institutional ETF users plan to increase the share of portfolio assets that they invest in ETFs over the next two years.

Furthermore, the study shows that among asset managers, 53% say that ETFs are used to gain active exposure to international equities and 43% use ETFs for active exposure to domestic equities. “These respondents are not necessarily using actively managed ETFs, but rather use passive ETFs to gain a tactical active exposure,” the study asserts. Meanwhile, institutional funds are less likely to view ETFs as an instrument to gain active exposure, with 23% and 15% using ETFs to gain a tactical active exposure to domestic and international equities, respectively.

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Liquidity has emerged as the most important factor for both asset managers and institutional funds when it comes to selecting an ETF provider, the report by Greenwich Associates reveals. Following liquidity, institutional funds focus on providers’ expense ratios and tracking errors, followed by the strength and reputation of the fund company behind the funds, as well as the track record of the fund itself.

The study was conducted by Greenwich Associates and sponsored by BlackRock and was based on interviews with 45 institutional funds — including corporate pensions, public pensions, and endowments and foundations — and 25 large asset management firms in the United States collectively overseeing roughly $7.5 trillion.

In a recent interview with BlackRock’s Deborah Fuhr, she noted that she has witnessed heightened scrutiny of exchange-traded products due to ballooning interest among institutional investors, adding that regulators have enhanced their scrutiny over these products. “Exchange-traded funds (ETFs) have grown very quickly relative to other products, especially outside the United States, which has driven the analysis that has been undertaken by regulators,” Fuhr told aiCIO, referring to recent warnings over the increasing complexity of exchange-traded products by the Financial Stability Board, the International Monetary Fund, and the Board of International Settlements. “ETFs have risen in popularity within the retail and institutional sectors, so I think the concern is to make sure regulators understand the products that have been growing and evolving very quickly.”

According to Fuhr, the legacy of Lehman Brothers’ bankruptcy and of the financial crisis more broadly was that regulators need to take a closer look at the unexpected. “Any product that has grown significantly is important,” she said, noting that while it took mutual funds roughly 66 years to break through $1 trillion in the United States, the growth in ETF assets in the US reached $1 trillion in only 18 years.



To contact the <em>aiCIO</em> editor of this story: Paula Vasan at <a href='mailto:pvasan@assetinternational.com'>pvasan@assetinternational.com</a>; 646-308-2742

SEC Joins Other Entities in Investigating FX Trading

The Securities and Exchange Commission (SEC) is looking into whether both State Street and BNY Mellon misrepresented how they intended to conduct foreign exchange trades.

(May 24, 2011) — The Securities and Exchange Commission (SEC) is heightening its scrutiny of foreign-exchange trading.

According to the Wall Street Journal, the SEC is probing whether two of the world’s largest custody banks — State Street and BNY Mellon — made proper representations to pension fund clients about the manner in which their currency trades were handled and priced. While State Street had already revealed the investigation by the SEC into its currency trades, it hadn’t been previously known that the SEC was examining BNY Mellon’s activities.

In its latest quarterly filing, Boston-based State Street, the third-largest custody bank, noted that “attorneys general from a number of [states] as well as US attorney’s offices, the SEC and other regulators have made inquiries or issued subpoenas.” State Street is also currently being investigated by Massachusetts’ chief securities regulator over its handling of foreign-exchange transactions. Regarding the pricing of its foreign-exchange transactions, State Street has already been sued by California and the Arkansas Teacher Retirement System for alleged fraud. Filed in early February in the US district court in Boston, the suit alleges that State Street, the custody bank for more than 40% of US public pension funds, violated state law by overcharging customers for currency trades. According to the suit, the bank generated as much as $500 million in profits annually — a rate of profit that accounts for about 50% of State Street’s foreign exchange profits over the last decade. In response, State Street said the Boston-based company is “firmly committed to providing its clients with quality service and transparency in meeting their FX needs. We will vigorously defend the allegations made in the complaint and we stand by our business practices,” State Street said.

Industry observers have been criticizing custodial banks recently over this practice. Chris Havener, Founder & Managing Director of Royal Oak Capital Management, told aiCIO that even though the foreign exchange market is an efficient market pricing system, the issues that have arose over forex pricing highlights the inefficiency in the way banks and pensions are interacting. “There are no regulations within the FX market. Trades happen 24 hours a day, all over the world,” he told aiCIO. “State Street and other large banks have been asleep at the wheel,” he said.

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“Pension funds, which pay millions and millions of dollars in custodial fees, have been lazy. They decide to outsource to custodial banks, and they don’t understand FX issues. Pension funds’ Chief Financial Officer or Treasurer should look at the time and price of trades, but they don’t,” Havener indicated, adding that pensions are slowly waking up to the problem of FX manipulation.

“This isn’t a perfect world, and despite greater scrutiny, this problem will persist.” Havener said. “This is the problem when you have people running other people’s money. Even though banks have a fiduciary responsibility to their clients, pension funds have dropped the ball on this…Perhaps, but not likely, this will serve as a wakeup call to act upon their naivety.”

The solution to avoid misrepresentations in regards to foreign-exchange trading is for banks and pensions to form contractually-bound agreements, setting more specific details on the pricing of currency trades, according to Havener. However, smaller companies will not have the clout of larger funds in negotiating contracts, he added.



To contact the <em>aiCIO</em> editor of this story: Paula Vasan at <a href='mailto:pvasan@assetinternational.com'>pvasan@assetinternational.com</a>; 646-308-2742

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