Wednesday, May 16, 2012 Stamford, CT USA — Institutional investors that began using exchange-traded funds (ETFs) for manager transitions, rebalancing and other tactical applications are increasingly employing ETFs for strategic purposes, such as gaining long-term exposures to desired asset classes. When looking to invest in ETFs, U.S. institutions turn most often to iShares, BlackRock's ETF business.
The results of a recent study by Greenwich Associates show that 57% of institutional ETF users employ these products to achieve strategic allocation ranges — a share that includes one-third of asset managers and nearly 60% of institutional funds using ETFs. Those shares have both grown since last year, when, among ETF users, about 50% of institutional funds and a quarter of asset managers said they used the product to achieve strategic allocation ranges. "Many institutions consider strategic applications to include liquidity overlays or longer-term over-weights, perhaps to an asset class or a single country, especially if the security is held for more than 12 months," explains Jennifer Litwin, a senior director at Greenwich Associates.
The annual study was conducted by Greenwich Associates and sponsored by iShares. The results are based on interviews with 80 institutional investors, including corporate pensions, public pensions, and foundations and endowments — all collectively referred to as "institutional funds" — and large asset management firms.
From Tactical to Strategic
Institutions are often first drawn to ETFs for help with two basic functions: manager transitions and cash equitization/interim beta. Among users of ETFs, 78% of asset managers and 44% of institutional funds use the products for cash equitization/interim beta. Both of those percentages are up meaningfully from 2011. Another 61% of asset managers and 55% of institutional funds in this group use ETFs in manager transitions.
The results of this year's Greenwich Associates study suggest that, once institutions integrate ETFs into their manager transition or cash equitization processes, they begin seeing additional applications for the products relatively quickly. One good example: In 2011, 44% of institutional fund managers that use ETFs employed them in their rebalancing processes. In 2012 that share rose to more than half.
These shifts illustrate what appears to be the natural pattern: Institutions start using ETFs to achieve specific and limited tactical goals such as a smooth transition of assets from an outgoing manager to a replacement, but over time begin applying exchange-traded funds to more strategic ends. For example, last year, approximately one-in-five institutional users of exchange-traded funds used them for portfolio completion. A year later, that share increased to 28% among asset managers and to 42% among institutional funds.
Longer Holding Periods
Reflecting the increasingly strategic role that ETFs are taking in institutional portfolios, the average institutional holding period for ETF investments expanded meaningfully over the past year. In 2012, about half of institutional funds using exchange-traded funds reported average holding periods of one year or more, with 36% reporting average ETF holding periods in excess of two years. Last year, only 36% of institutional funds reported average ETF holding periods of a year or longer. Though funds with less than $5 billion in assets under management are most likely to hold ETFs for longer periods, 43% of funds above the $5 billion mark also report holding ETFs for a year or more. Meanwhile, the share of asset manager ETF users reporting holding periods of a year or longer increased to one-third in 2012 from just 18% in 2011, and 22% of asset managers this year report average ETF holding periods of two years or longer.
Projection: Modest, Steady Increase in Institutional ETF Activity
About 14% of U.S. institutions currently use ETFs in their portfolios, according to the results of the Greenwich Associates 2011 U.S. Investment Management Study. Among current ETF users, 40% of institutional funds and one-third of investment managers expect to increase allocations to ETFs in the next 12 months, while 22% of institutional funds and 14% of asset managers plan to trim ETF allocations. "While the share of institutions using ETFs was stable from 2011-2012, the results of the more recent ETF study suggest that institutional allocations to ETFs will increase to at least some extent in the coming year as investors find new ways of employing them in their portfolios," says Greenwich Associates consultant Andrew McCollum.
Nearly 90% of institutional funds and asset managers that employ exchange-traded funds use iShares as a provider, making the company by far the most widely-used ETF provider in the institutional market. Among ETF users, 61% of asset managers and 47% of institutional funds use SPDRs/State Street as an ETF provider, and half of asset managers and nearly 40% of institutional funds use Vanguard. Although each of these leading firms is well regarded in certain aspects of their businesses, iShares is most frequently cited for "best range of products," "strong servicing platform," "being a safe choice," "providing liquid products," and "strong index tracking." Vanguard leads the way with most mentions for "good value."