Reshaping the Narrative

The institutional adoption of exchange-traded funds (ETFs) is no longer defined solely by efficiency or convenience. What initially began as a tool for transition management has matured into a foundational element of institutional portfolio construction. Today, ETFs are reshaping how investors think about liquidity, benchmark alignment, and precision exposures—not as short-term instruments, but as infrastructure for long-term implementation.

We examine how institutions are moving beyond traditional ETF narratives—leveraging them to strengthen implementation, reframe strategic decisions and challenge persistent misconceptions.

How ETF Usage Has Evolved in Institutional Portfolios

Institutional use of ETFs has significantly advanced over the past two decades, and many institutions have progressed through a similar set of milestones: 

  • Transition management: ETFs were first used as temporary placeholders during manager changes or asset reallocations—valued for their liquidity, speed, and low cost. For example, broad equity index ETFs (such as S&P 500 or MSCI EAFE trackers) gave institutions immediate market exposure while new mandates were being funded.
  • Benchmark tracking: Institutions began using ETFs to gain broad, policy-aligned exposures more efficiently than building them with active managers. For example, large-cap equity ETFs, core investment-grade bond ETFs, and international developed-markets ETFs are often mapped directly to IPS benchmarks. Using ETFs to track policy benchmarks reduces operational complexity, lowers trading costs compared with holding hundreds of individual securities, and provides daily transparency on exposures.
  • Tactical allocations: As familiarity grew, institutions started using ETFs to gain exposure to attractive, timely opportunities based on internal market views. For example, high-yield bond ETFs, sector-focused equity ETFs (e.g., technology or energy), and commodity ETFs (such as gold) enabled institutions to express short-term views quickly and at scale. The benefit over traditional active mandates is faster implementation and easier reversal when views change.
  • Strategic asset allocation: Today, many institutions incorporate ETFs as permanent holdings to enhance liquidity, precision, and implementation control. For example, factor ETFs (such as minimum volatility or quality) and targeted fixed-income ETFs allow institutions to fine-tune risk exposures and maintain liquidity buffers within their long-term portfolios. Compared to traditional commingled funds or separate accounts, ETFs provide more flexibility, intraday tradability, and lower administrative burden.

This evolution has given rise to a variety of applications, several of which are now foundational to long-term institutional portfolio construction.

Strategic Asset Allocation: Five Key ETF Use Cases

The current landscape of institutional ETF use reflects both innovative application and deliberate, long-term strategy. Here are five of the most prevalent ways institutions are using ETFs today:


Rethinking ETF Size and Liquidity

A common misconception among institutions is that ETF size equals ETF liquidity. In reality, the liquidity of an ETF is tied to the liquidity of its underlying holdings, not the vehicle’s trading volume or assets under management (AUM). 

That said, many consultants and institutions still use a $1 billion AUM threshold as a screening tool. While this can simplify diligence, it may also exclude ETFs that deliver unique or differentiated exposures in underrepresented areas like real assets or targeted credit. For these use cases, institutions increasingly accept ETFs with $250–500 million in AUM when paired with education on trading mechanics and structure. In fact, U.S.-listed ETFs with less than $1 billion in AUM have seen $728.2 billion in net new assets (NNA) year-to-date, building off the strong momentum they had in 2024 when they garnered $1.05 trillion in NNA.1 

Furthermore, ETF shares can trade at tighter bid-ask spreads than their underlying holdings in some cases—a testament to their ability to provide liquid, efficient exposure. For example, one Northern Trust fixed income ETF with $1.2 billion in AUM has a 30-day average spread of $0.01, or 0.028%, compared to the spread of the underlying bonds, which averaged $0.55 or 0.63%.2 

Leading asset managers often have ETF capital markets desks and ETF product specialists who can help institutions navigate large trade sizes and better understand their size and liquidity concerns.

Explore how ETFs can improve liquidity in institutional portfolios

ETFs as Enablers of Precision and Progress

Beyond the product itself, the adoption of ETFs is also heavily driven by the infrastructure and expertise that support them. For example, Northern Trust’s ETF specialists work alongside asset class and capital market experts to help institutions align ETFs with broader investment strategies, providing guidance on everything from execution to portfolio fit.

This institutional support extends beyond investment considerations. For organizations new to ETFs, operational factors such as setting up brokerage accounts or updating internal processes can be meaningful hurdles. 

Ultimately, whether the goal is benchmark alignment, risk management, or liquidity planning, ETFs offer institutions a flexible and powerful toolkit for long-term portfolio construction. As innovation continues across systematic strategies, real assets, and fixed income, the role of ETFs in institutional portfolios is poised to expand even further.

Explore how ETFs can fit into your portfolio

1 Source: Nasdaq ETF Intel.

2 Source: Northern Trust Asset Management, as of 8/21/2025.
 

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