The exchange traded fund industry recently recorded its best annual growth spurt despite the market volatility, and the industry could enjoy an even faster expansion as institutional investors increasingly utilize the investment tool.
According to a recent Greenwich Associates Study, Institutional Investment in ETFs: Versatility Fuels Growth, U.S. institutional investors plan to increase their use of ETFs in 2016.
Institutional investors currently make up about 36%, or $756 billion, of the $2.1 trillion in U.S.-listed ETF assets. Of the surveyed 183 U.S. institutional investors, about 43% of institutional investors hold 10% or more of their overall portfolio in ETFs, and almost 20% of non-ETF users are considering ETFs for their portfolios this year.
The report found that institutional investors are incorporating ETFs as a means for long-term, strategic allocations as well as cost-effective replacements for traditional bond securities and derivatives. Around 82% of investors indicated that targeting certain market exposure was the most important factor for selecting an ETF. Institutional investors also pointed to liquidity or trading volume, expense ratio and tracking error of the funds as some of the most attractive factors for investing in ETFs.
“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,” Daniel Gamba, Head of iShares U.S. institutional Business at BlackRock, said in a press release. “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.”
Among the participants who utilized equity ETFs, 36% expect to raise allocations in the year ahead and 35% of those plan to increase allocations by 10% or more.
“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,” according to the report. “The most popular application for ETFs within institutional portfolios is obtaining core exposures — undoubtedly a strategic function.”
About 35% of fixed-income ETF users expect to add allocations this year, with 36% planning boost allocations by 10% or more.
“Fixed income ETF use is expanding: 65% percent of institutional ETF users employ the funds in fixed income,” according to Greenwich Associates. “Liquidity issues have led many institutions to adopt fixed income ETFs, as ETF liquidity has increased dramatically over the same period.”
Over half of the institutions are also replacing traditional derivatives products with ETFs in the past year, and 78% of futures users plan to replace existing futures postilions with ETFs over the next year.
Smart-beta strategies, or ETFs that track alternative indexing methodologies, have been gaining popularity among institutional investors, with 30% of institutions employing a smart-beta ETF and an equal percentage are using currency hedged ETFs.
Max Chen contributed to this article.