Institutional investors could help run the next leg of growth in the exchange traded fund industry as more capitalize on the flexibility and low costs of the relatively new investment vehicle.
Large investors including pension funds and insurers are beginning to shift away from mutual funds and into ETFs, report Joe Rennison and Gavin Jackson for the Financial Times.
According to the Investment Company Institute, between 2007 and 2015, the U.S. equity mutual fund industry shrunk by $410 billion while U.S. domestic equity ETFs brought in $730 billion in net inflows.
Over the years, institutional ETF usage has surged. According to ETFGI data, in 2007, the U.S. ETF industry held $621 billion in assets under management, with institutional investors contributing $370 billion. By the end of 2014, the ETF industry grew to over $2 trillion in AUM, with $1.16 trillion from institutional investors.
Enticing larger investors to the ETF investment vehicle, the ease at which institutional investors can trade ETFs has been a boon for the industry – ETFs, like stocks, trade on the stock exchange throughout the day. Consequently, many institutional investors enjoy being able to sell ETFs at a moments notice to meet cash demand from clients to redeem their holdings.
In contrast, mutual fund redemptions can take longer to accomplish, especially for less liquid assets like bonds, which can prove difficult to liquidate during times of rising volatility.
Some institutional investors have increasingly turned to ETFs as low-cost alternatives to options and derivatives to hedge market positions as increased financial regulation raised the cost of trading derivatives. [ETFs Begin to Muscle in on Derivatives Market]
[related_stories]The ETF industry may still gain ground among institutional investors as many have not fully expanded into ETF options. For instance, hedge funds are only just beginning to adopt more asset classes, notably commodity ETFs. Pension funds have largely stuck to equities. Meanwhile, insurance companies have only recently begun using ETFs and typically focused on fixed-income options – percentage of U.S. insurers investing reserve assets in ETFs has increased from just 6% in 2013 to 71% in 2015.
Hedge funds and brokers lean toward State Street’s SPDR ETFs due to their deep liquidity. For instance, the SPDR S&P 500 ETF (NYSEArca: SPY), which has $181.6 billion in assets under management and an average daily volume of 128.8 million shares, has been a fan favorite.
On the other hand, investment advisors who are more strategic with their allocations have focused on fees and tracking of the underlying assets. Consequently, advisors have favored ETFs from the Vanguard Group. For instance, the Vanguard 500 Index (NYSEArca: VOO) has attracted inflows last year while SPY saw outflows, which suggests that some long-term investors may be switching to the cheaper 0.05% expense ratio found in VOO, compared to the 0.09% fee for SPY.