An increasing number of institutional investors are looking to exchange traded funds as easy-to-use active investment tools to construct, maintain and adjust a diversified portfolio in changing market conditions.
According to a recent Greenwich Associates survey of 187 institutional investors between October 2016 and January 2017, an increasing number of institutional investors are allocating a larger portfolio of assets into ETFs.
“Institutional assets are flowing into exchange-traded funds (ETFs) as U.S. institutions integrate them into essential portfolio functions ranging from risk management and liquidity enhancement to the generation of income and yield. As such, ETFs appear to be on track to eventually becoming as common in institutional portfolios as stocks, bonds and derivatives,” according to Greenwich Associates.
Currently, only about one in five U.S. institutions invest in ETFs, but those that hold ETFs have multiple years’ experience investing in the funds. The institutions incorporate ETFs into their portfolios as tools for obtaining strategic investment exposures, and they often include ETFs alongside their stock, bond and derivatives holdings.
Moreover, institutions are capitalizing on ETF’s many positive characteristics, like liquidity, ease of use and quick market access to garner exposure to a broad and expanding range of portfolio applications.
As of the end of 2016, institutional investors held an average 21% of total assets in ETFs, compared to 19% in 2015, and allocations are expected to continue to grow in 2017. About 47% of equity ETF investors and 38% of bond ETF investors anticipate an increase in their allocations to ETFs in the year ahead as well.
Supporting the ongoing growth in demand for ETFs among institutional investors, the ETF investment tool is being viewed as a new class of financial instrument, a number of smart beta ETFs have risen to meet challenges in institutional investors’ portfolios, notably in multi-asset funds, and bond adoption is quickly gaining on equity ETF demand.
About 52% of institutions that use derivatives to access beta indicated they have replaced an existing derivatives position with an ETF in the past year and one-third of institutions plan do so in the next year.
A number of institutions are looking into innovative ETF exposure through smart beta or alternative index-based strategies to navigate the changing market conditions, such as a low rate environment and rising market volatility. About 37% of institutional ETF users invest in smart beta ETFs as of the end of 2016, compared to 31% in 2015. Of those currently investing in smart beta ETFs, 44% expect to raise allocations to the various strategies in the next year.
Around 52% of asset managers use ETFs as part of multi-asset funds managed for clients, compared to 35% of asset managers employing ETFs in these funds in 2015.
Assets in bond ETFs expanded by almost 26%, compared to the 18% growth in U.S. equity ETFs, and the bond ETF space has much more room to grow. Along with the 38% of current bond ETF institutional users expecting to increase allocations, 17% of current non-users are considering investing in the funds in the year ahead.
Lastly, previous impediments that kept institutional investors away from the ETF space are giving way. For example, fewer institutions are concerned about ETF liquidity and expenses. Furthermore, the number of restrictions is falling with only 19% of non-users saying they were prevented from investing in fixed-income ETFs by internal investment guideline restrictions, compared to almost a quarter of non-users back in 2015.
For more information on ETF usage, visit our ETF performance reports category.