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Move to ETFs Among Institutional Investors Growing, But Its Not Because Of Passive

Institutional use of exchange-traded funds has been growing and is likely to continue, a Greenwich Associates study found. In a rising interest rate environment where volatility is expected to exert a more frequent influence, the flexibility and cost-practical nature of the vehicles was cited as a motivator. While this points to a growing passive trend, the institutional investors surveyed revealed active investment methods are also driving ETF usage.

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Even before the February 2018 volatility-led market crash, institutional investors were preparing their portfolios for a return of volatility and a shift to a rising interest rate environment, a Greenwich Associates report noted. Over half the U.S. institutions responding to Greenwich Associates 2017 U.S. ETF Study say volatility, geopolitics and unforeseen external factors roiling markets are the top challenges for the year ahead.

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To adjust market exposures for these uncertain times, investors have been decidedly turning to ETFs.

ETF allocations average 38% an asset manager’s portfolio and 31% for insurance portfolios, with nearly one-third planning on increasing such allocations in the coming year. Almost 20% of institutions not currently utilizing equity ETFs say they somewhat likely to do so in the next 12 months.

“ETFs provide a liquid vehicle to express a more timely view of a particular sector of the market or an opportunity that’s available or to decrease risk temporarily in the portfolios,” one study participant told Greenwich. “The transition from high risk to low risk in a nimble way is very important, and ETFs are great for that,” said another study participant.

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Some investors considered the US markets “efficient,” and that individual stock picking was not as effective a strategy as asset allocation. “The nice thing about ETFs is that it doesn’t cause us to be an equity stock picker,” one study participant said. “It allows us to be simply an asset class picker.”

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The report noted that ETFs are becoming more popular in part because they provide an efficient source of flexible beta exposure as well as being a method to produce alpha based on asset allocation as opposed to stock picking. “We are a top-down manager, so we like to choose an asset class and go down from there,” says one study participant. “The nice thing about ETFs is that it doesn’t cause us to be an equity stock picker. It allows us to be simply an asset class picker.”

ETFs are being used in portfolios alongside individual stocks, bonds, mutual funds and derivatives – and in many cases replacing them. The top products being displaced by ETFs include active mutual funds (59%) and individual stocks (41%.) Nearly half of study participants that use futures for beta exposure have replaced at least one derivatives position with an ETF in the past year, with the drag of the futures roll to the forward trading month being cited as a concern. Of those who plan on switching out of derivatives, 58% in the Greenwich study say they are doing so to lower costs.

While ETFs are often characterized for their lower costs, the most famous reasons for institutional investors using them include quick access (86%), ease of use (82%), liquidity (81%), and single-trade diversification (77%). Low management fees and trading costs ranked fifth and sixth respectively as the top motivators to use the products.

While ETFs are used to gain broad access to the general beta, smart beta applications are also popular, particularly those that apply factor-based investment strategies and other rules-based methods. The most popular are minimum-volatility ETFs that help protect portfolios against volatility increases.

Are active investors digging their graves by propping up (mostly) passive style ETFs?

 

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