Institutional investors use ETFs for fixed income, smart beta

Canadian institutional investors hold an average of 16% of total assets under management in ETFs, finds a survey by Greenwich Associates, sponsored by BlackRock. And more than a quarter of survey respondents plan to increase their ETF holdings in the next 12 months.

Helping to drive this adoption is the increasing use of ETFs to express strategy, as opposed to tactics.

More than half of institutional investors (58%) characterize their ETF holdings as strategic. Further, nearly two-thirds (63%) hold their ETF investments for a year or longer, the threshold normally considered for a strategic investment.

For instance, two of the top-three institutional uses of ETFs — international diversification (cited by 71% of respondents) and core allocation (55%) — are strategic in nature.

“Strategy now trumps tactics when it comes to ETF use,” says Warren Collier, head of Canada iShares for BlackRock Canada, in a release. “Where it gets really interesting is how sophisticated those applications have become.”

Institutional investors make ETFs increasingly important components in critical portfolio functions. Nearly half are using the funds in their liquidity management strategies, and two in five employ ETFs as part of risk management and overlay strategies.

Read: Alternatives to 60/40 portfolios

Liquidity needs drive growth in fixed-income ETFs

Nearly all survey respondents invest in equity ETFs, but they also take advantage of diverse asset classes, using ETFs to gain exposure to REITs (20% of respondents) and commodities (15%). A full two-thirds invest in bond funds.

On average, Canadian institutional ETF users invest about a quarter (26%) of total fixed-income assets in bond ETFs — more than three times the average allocation among counterpart European institutions. One reason lies in the particularly large allocations by insurance companies, some of which hold 35% of fixed-income assets in ETFs.

Liquidity as the main reason for using fixed-income ETFs is cited by more than 80% of respondents. That’s because, post-financial crisis, the global landscape is shifting to require greater capital requirements for banks in Europe and the U.S. Continuing concerns over liquidity could well drive further adoption of ETFs by Canadian institutions, many of which have been exposed to liquidity constraints when investing in international fixed income.

Read: How asset managers are adapting to fragile bond liquidity

Low rates drive growth in smart beta ETFs

Almost a third (31%) of surveyed institutional investors use smart beta ETFs, and more than half of them plan to increase their allocations to these funds over the next year.

Read: Smart beta ETF assets reach record high

Multi-factor ETFs continue to be popular, but more than half of smart beta ETF users now hold equity-income ETFs. It’s a notable development, considering last year’s study indicated investors weren’t using these ETFs but instead favoured minimum-volatility ETFs. According to Greenwich Associates, the use of these ETFs in a sign of institutions’ need for new income sources in the low-rate environment.

Read the full survey.

About the study: Greenwich Associates interviewed 53 institutional investors, including 25 asset managers, 24 institutional funds and four insurance companies. Of those investors, 38% manage more than $5 billion, 18% more than $20 billion and 8% more than $100 billion.

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