ETFs are becoming one of institutional investors’ preferred means of gaining exposure to index strategies, as witnessed by the $225 billion they put into index ETFs last year. According to a new study from Greenwich Associates, this is only a piece of the evolving ETF story. The report, “Active Strategies, Indexing and the Rise of ETFs,” notes that institutions are likewise employing forward-thinking investment approaches and novel ETF structures to liquidity and risk management, as well as other portfolio functions. The future outlook is bullish, too: BlackRock forecasts that smart beta ETF assets will hit $1 trillion by 2020 and reach $2.4 trillion by 2025.
Investors are now using index products to procure, in essence, active exposures, with security selection being replaced by asset allocation as the main source of alpha.
In research conducted over the past six years, Greenwich Associates has seen institutions increasingly adopt ETFs, in no small measure due to their versatility. The funds are being employed in different ways in different places across an expanding array of asset classes.
• North America. It has become near-impossible to find an institutional portfolio in North America without ETFs. American and Canadian institutions “have integrated ETFs deeply into their portfolio management strategies,” according the report. Mostly, this has entailed using index products to build, sustain, and modify portfolios on a daily basis.
• Europe. Here, quantitative easing by the European Central Bank, among other strong market dynamics, as well as more market volatility and less liquidity in fixed income, is leading European institutions to up their ETF usage. Specifically, the report notes, they are putting ETFs to work helping “manage risk, enhance liquidity, and generate yield.”
• Asia. The main drivers of an expansion in ETF assets under management, says Greenwich Associates, are a rush of new institutional users plus, among current investors, ongoing growth in allocations. Almost all these investments up to now have come in international markets and internationally domiciled vehicles. The report argues, however, that “given the sizeable shares of institutions’ active and index portfolios invested locally and domestically, the development of these markets and the creation of new ETF within these markets will help spur future growth.”
For the moment, among current institutional users, ETFs constitute an average of 15 percent of total assets. U.S. ETF users have approximately 21 percent of their total assets allocated to ETFs, compared with 15 percent for Canadian ETF users. Explosive growth in Asia has seen current ETF users reach almost 18 percent of their total assets in ETFs, well outpacing institutional investors in Europe, whose allocations average 7.6 percent. The Greenwich Associates report noted that RIAs sport the largest allocations, at about 24 percent of total assets, just ahead of asset managers’ 20 percent.
The company’s prior year study projected $300 billion in annual institutional ETF flows by the end of this decade, and its latest report shows nothing to suggest that won’t in fact prove to be the case. New institutions plan to initiate these investment vehicles into their portfolios; current users are looking to grow allocations to ETFs. Indeed, almost 25 percent of institutions surveyed by Greenwich Associates that don’t currently invest in ETFs reported that they are at least “somewhat likely” to begin doing so in the coming year in both equities and fixed income; while almost half (45 percent) of institutions now investing in equity ETFs say they plan to bump up their allocations to these funds in the next 12 months.