How Institutions Adopt Indexed Products

There is a fresh-baked article just out on ETF.com, talking about a survey conducted by the Keefe, Bruyette & Woods regarding the institutional use of ETFs. The key insight from this written-up struck not only the readers but the surveys surprising – ETF adoption remains low even the market is flooded with the ETF buzz words and net assets keep flowing from mutual funds to ETFs, just last year (2017), about $182 billion flowed into them.

According to the Keefe, Bruyette & Woods analyst Mellisa Roberts, one questions they asked during the survey was, ‘What percentage of your AUM is invested in exchange-traded products?’ and 53% of respondents had 0% in ETFs. The remaining 47% had less than 10% of their AUM invested. she stated people would’ve thought those numbers would have been higher based on the growth of ETFs over the last couple of years. They abhor blindly betting on hot ETFs, rather, they choose precise exposure ETFs.

Further questions such as their reaction to the word ETF and planning of utilizing ETFs in the future reveal that these institutional money managers tend to take a hostile, ridiculing attitude toward ETF “mania”, however, they set the plan to ramp up usage of ETFs in their portfolio meanwhile. For them, as of now, there are three main ways ETFs are being used –  “the first being for liquidity, the second for shorting and hedging, and the third for long positions and to lend out the securities.”

My view of this somewhat surprising outcome is that it’s attributable to the surveyees. Citing the definition of the CFA Institute, “Broadly defined, institutional investors include retirement plans such as defined benefit or defined-contribution plans, grant-making organizations, endowments, insurance companies, banks, sovereign wealth funds, and investment intermediaries”.

According to Steven A. Schoenfeld in his book Active Index Investment published in 2004, Chapter 26 – How and Why Large Pension Plans Use Index-Based Strategies as Their Core Investments, sub-author Nancy Calkins elaborated the adoption and usage of ETF for their core strategies by pension fund managers. The satellite strategy calls in professional managers based on their expertise on picking stocks, I surmise they compose a bulk of this survey, and hence hold a hostile attitude toward ETFs.

taking a more objective, broader way to look at the institutional use of ETFs, I see things three major categories:
1. Instead of competing with ETFs, large institutions join the force by issuing ETFs themselves. Their ETFs have two kinds. true form and pseudo form ETFs, the latter ones are still actively managed with a high commission fee, but open-endly listed. We witness Invesco, Fidelity, Nomura, Legg Mason, Goldman Sachs, JPMorgan… are all entering the space of ETFs ostensibly or stealthily.

2.  Continue and enhance the use of ETFs as the core in their core/satellite strategies.

3.  Creating index/benchmark to assist their active stock–picking and risk management. This kind of products don’t need the strenuous-efforts-requiring ETF  launching, but more bespoke and flexible index creations. Such demand is growing rapidly in the market.

As to individual investors and advisors, they embrace ETFs full-heartedly due to great advantages ETF offer – risk diversification, liquidity, low cost, tax efficiency, and foremost importantly, stellar performance compared to the mutual funds.

 

 

 

 

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