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February 25, 2007 at 02:00 PM
The United States exchange traded fund (ETF) market has shown rapid growth in both assets and new listings in the past 14 years. This underscores the importance of indexing as a winning long-term investment strategy with important opportunities for insurance products, especially variable annuities.
Consider: Nearly 16% of all U.S. equity assets (almost $1 trillion) is invested in ETFs and open end index funds. They’ve had an 11-year percentage compound annual growth rate of about 13%. Furthermore, numerous studies continue to show that in the long-term, indexing usually outperforms active management. These trends suggest that ETFs might be the solution variable product insurers have been looking for to provide low-cost, efficient and diversified investment options.
Why? Because ETFs can offer precise strategic broad market or market segment exposure tailored to client investment goals, risk tolerance and time horizon. They are also ideal for use with sophisticated portfolio management techniques–e.g., tactical asset allocation, sector rotation strategies, hedging strategies, cash equitization, portfolio completion, account transitioning and more.
The VA market, in particular, can benefit greatly from ETFs’ attributes. Today, about 70+% of all VA and variable life asset flows are directed toward strategic asset allocation (SAA) funds-of-funds–either risk-based or life-cycle oriented. This has allowed variable contract holders to diversify risk across multiple asset classes with one investment. It has also benefited the insurers by allowing them to better price and hedge guarantees.
That is why integrating ETFs into the VA market is a natural fit. Here are 4 primary benefits to this integration:
o ETFs are designed to track benchmarks that are published daily. This makes their allocation very transparent to investors. ETFs either replicate indexes entirely or construct optimized portfolios, investing in a representative sample of the stocks in the underlying index. With ETFs, investors know exactly what they own.
o ETFs can improve insurers’ ability to create low cost, transparent strategic asset allocation portfolios with easily priced and hedged risk/return characteristics. The average expense ratio for equity mutual funds (domestic and international) is 1.59% (according to Morningstar Principia) versus the current average expense ratio for all ETFs of 0.42%. Such differences represent a significant opportunity to decrease the fees VA customers pay for financial products and services.
