ETF Shopping, Pension Style

Are plan sponsors putting the right things at the top of the shopping list?

May 30, 2013

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shopping cart_edited-1Pension funds are looking at exchange-traded funds (ETFs) through a whole new lens. Last week, I wrote about how they’re putting them to longer-term use, according to a new Greenwich survey that shows institutional investors, including pension funds, using ETFs strategically rather than simply as a quick way to get in and out of specific markets.

But as institutions use ETFs more strategically, are they changing how they shop for them? What characteristics are they looking for? According to Greenwich, liquidity and trading volume still top the list of what institutions want: 76% ranked this a No. 1 factor. Second is cost, with 68% of institutions listing the fund’s expense ratio as a driving factor behind selection.

Surprisingly, however, tracking error and the type of benchmark used rank further down the list—third and fourth, respectively—with roughly half (49%) of respondents looking closely at an ETF’s tracking error as a big part of selection and only 39% considering the benchmark being used.

While the Greenwich survey numbers I looked at didn’t break down those top factors by type of investor, I suspect pension funds might put more weight on tracking error and the underlying benchmark. A case and point is what happened last year: ETF provider Vanguard made the decision to shift away from MSCI indexes, and that caused a big stir within the pension world here in Canada. Not all indexes are the same, and that is something pension funds must be aware of. For example, Vanguard’s move to FTSE from MSCI raised a lot of questions in the plan sponsor space about how the underlying exposure had changed. For example, the MSCI EAFE Index and the FTSE Developed Ex North America Index have a greater than 10% difference in holdings. Countries differ, too—you’ll find Korea listed as a developed country by FTSE but as an emerging market with MSCI.

Tracking error is another big issue for plan sponsors, which need to make sure a specific ETF is delivering what it’s supposed to—pure passive exposure to an index without any surprises.

I would expect that as we see a growing tendency for pension funds to use ETFs strategically, these two factors would move up the shopping list.

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