Study: Institutional Investors Seek ETFs

(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.

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.