Institutions own 64% of the 20 biggest ETFs—and they’re using them to manage risk
Demand for ETFs among institutions is being driven by liquidity.
September 25, 2013
According to a new report on institutional exchange-traded fund (ETF) usage by institutional investors, no one is keeping direct statistics on exactly how institutions are using them. This is a shame, because institutions are fast-becoming the dominant owners of the 20 largest U.S. ETFs.
ETFs: Increased Liquidity and Produce Range Drive Institutional Participation—a report issued by Moody’s Investors Services—shows that institutions own just over 64% of the outstanding shares of the 20 biggest U.S. ETFs with hefty holdings in the S&P 500 (85.53%), the Russell 2000 Index (136.43%, which exceeds 100% due to duplicative reporting of shares lent out short), the High Yield Corp Bond (80.08%) and the MSCI EAFE Index (88.17%).
The big demand for ETFs among institutions is being driven, in large part, by their liquidity, which, according to Moody’s, has risen over the last few years. Moody’s also notes that ETFs are now seen as risk management tools: institutions that once would have used futures or swaps to deal with macro risks in broad sectors and asset classes are now turning to ETFs because they’re not as demanding from an operational perspective. “ETFs provide portfolio managers an easy way to adjust exposures to major risk factors, including equity, credit and rate risks, and to incorporate various investment-style factors, such as size and value,” reads the report.
Moody’s claims that more institutional investors are also using ETFs for shorting and tail hedging as hedge fund and other absolute return-seeking investors look for simpler ways to get in and out of markets. For example, hedge funds now commonly short major index ETFs—such as the SPY (S&P 500) and the IWM (Russell 2000)—to bring down their long market exposure and achieve their desired beta to the equity markets. And long-short equity hedge funds are using ETFs and put options as a proxy for short exposure to single stocks, especially when capacity constraints are at play. You’ll also find more institutions piling into ETFs that would benefit from a flight to quality (i.e., U.S. Treasuries) or those linked to volatility (VIX futures).
What’s clear from the Moody’s report is that institutional money is a dominant force in the ETF space, and, at the same time, ETFs are changing the way institutions manage risk. Now that ETFs are an important tool for big investors, what does it mean for the broader market?
Unfortunately, it’s hard to tell because, as Moody’s points out, we don’t have consistent or clear statistics on institutional use of ETFs. I think it might just be time to change that—more data could help institutions both refine and expand their use of these products. And it could help ETF providers create more tailored products that meet their needs.