Changing the conversation about ETFs

Investors assumptions about what ETFs are and aren't have changed radically in a short time.

May 29, 2014

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whisperToday, exchange-traded funds (ETFs) are a portfolio staple for some of the biggest investors in the world, in Canada and elsewhere. Last week, for example, I wrote about how the Ontario Teachers’ Pension Plan was using ETFs as a tool for expressing the pension fund’s views on emerging markets: having snapped up emerging market ETFs to capture an upswing in market growth, Teachers’ had shed a significant part of its ETF portfolio on a worsening emerging market outlook. By contrast, the headline-making Yale Endowment Fund says it’s piling into emerging market ETFs.

And that’s just one of the many examples of institutions that are using ETFs more strategically.

The extend to which institutional investors are changing the way they see and use ETFs was captured perfectly in thelatest data from Greenwich Associates. It was released a couple of weeks ago and what strikes me about the data is the way it refutes just about every assumption that once kept institutions (especially pension funds) away from ETFs.

The ETF conversation is changing fast among institutional investors. And, according to Greenwich, that conversation means shedding a few key assumptions.

They’re not just about stocks – The biggest growth area for ETFs in the institutional space is fixed income, according to Greenwich. That’s a big turnaround for a product that institutions once perceived as equity products. According to the data, 66% of institutional investors are using ETFs in domestic fixed income portfolios—a steep climb from just 55% in 2013. Here the story is all about domestic fixed income; however, the share of asset managers jumped to 72% in 2014 from just 30% in 2013. International fixed income ETFs are also on the rise; however, asset managers didn’t have anything in 2013, but in 2014, nearly half of asset managers are using them.

They’re not short term – A couple of years ago, when I started writing this blog, plan sponsors were using ETFs primarily for short-term moves, such as transition management. According to Greenwich, that is changing: average holding periods are on the rise, as 49% of participants say they are holding ETFs for two years or more.

They’re not just for transition management – More and more institutions are also changing how they use ETFs, shifting from tactical moves to more strategic ways of using them, particularly pension plans—66% of them are using ETFs strategically, up from just 47% in 2013. Overall, 63% of institutional investors describe their ETF usage as strategic. Back in 2010, that number was a lowly 20%.

They’re not core-worthy – Today, the most common ETF application is core portfolio exposure, according to Greenwich, with 80% of institutions using them as a means of obtaining core portfolio exposures—that’s up from 74% in 2013. Back in 2010, the numbers were far different: only 19% of asset managers and only 28% of pension plans used ETFs as a core/satellite application. They’ve come a long way, baby.

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