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Why Institutional Investors Are Embracing ETFs

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Are ETFs really “weapons of mass destruction” as some critics claim? Despite the doom and gloom, U.S. banks, insurance companies, pension funds, and other large U.S institutions are increasing their ETF exposure.

U.S. institutions, which currently represent around $756 billion of the total $2.1 trillion in U.S. ETF assets, plan to increase their use of ETFs in 2016 according to findings from Greenwich Associates.

The firm’s new study titled “Institutional Investment in ETFs: Versatility Fuels Growth” shows that 36% of the institutions surveyed are planning to boost their equity ETFs this year while 35% plan on adding more fixed income ETFs to their holdings. The study was based on interviews with asset managers, institutional funds (pensions, endowments and foundations), RIAs, insurance companies and investment consultants.

Among the key drivers behind the trend are the following:

  • 68% of institutional ETF assets are now categorized as “strategic” in nature — a share that has climbed from 58% in 2013 and 63% in 2014. And while existing institutional users are finding new applications for ETFs inside their portfolios the most popular strategy is using ETFs to obtain core market exposure.  
  • ETFs are increasingly being used along with derivatives to hedge or gain market exposure. More than half the institutions in this year’s study replaced derivative products, such as equity futures contracts, with ETFs in the last year, and 78% of futures users plan to replace an existing futures position with an ETF in the next 12 months.
  • Insurance companies are adopting ETFs as a means of investing both surplus and reserve assets: As recently as 2013 only 30% of insurance companies used ETFs to invest surplus assets, and only 6% used ETFs to invest reserve assets. This year, 59% of insurers in the study are using ETFs for surplus assets and 71% are using ETFs to invest reserve assets, higher than expectations.
  • Roughly 30% of institutions are employing alternative beta (non-market-cap-weighted) ETFs, and an equal percentage are using currency hedged ETFs. Meanwhile, money managers with multi-asset-class funds are using ETFs to implement strategies or scale their products. ETFs now make up 48% of assets in multi-asset portfolios, according to asset managers running these funds.

Going back to 1993 and the launch of the very first U.S.-listed ETF, the SPDR S&P 500 trust, institutional money managers have been ETF adopters.

For financial advisors, the latest trends are a clear signal the “smart money” has embraced and will continue to embrace ETFs for portfolio management.

“U.S. institutions are contributing to the relentless growth of the ETF industry as they take advantage of the potential benefits and applications of ETFs,” said Daniel Gamba, Head of iShares U.S. institutional Business at BlackRock.

Beyond investment strategy, the increased ETF adoption rate is heavily influenced by bottom line numbers.

“Some investors are also reducing their portfolio costs by replacing futures with ETFs,” added Gamba.

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