Canadian institutions turn to ETFs for strategic goals

Mar 14th, 2017 | By | Category: ETF and Index News

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Canadian institutional investors are increasingly turning to ETFs to address strategic portfolio goals, with smart beta and fixed income ETFs highlighted as key areas of growth, according to a recent Greenwich Associates study.

Warren Collier BlackRock Greenwich Associates

Warren Collier, Head of Canada iShares for BlackRock Canada.

In its fourth annual study of institutional ETF use, sponsored by BlackRock Asset Management (BlackRock Canada), Greenwich Associates found an increasing adoption of ETFs by institutional investors – including asset managers, institutional funds and insurance-related firms –  for long term strategic purposes rather than shorter term tactical means. In fact, more than half (58%) of institutions characterized their ETF holdings as strategic in nature, and nearly two-thirds (63%) are holding their ETF investments for a year or longer, the threshold normally considered a “strategic” investment.

Warren Collier, Head of Canada iShares for BlackRock Canada, commented: “Institutional investors’ use of ETFs has grown in absolute terms in recent years, but this survey shows that it has also grown in diversity and sophistication. The Canadian industry started using the funds largely for tactical applications, but since then we’ve seen strategic applications grow to the point where strategy now trumps tactics when it comes to ETF use. And where it gets really interesting is how sophisticated those applications have become.”

According to the Greenwich Associates study, the benefits of ETFs for institutional investors are varied and broad. Almost 85% cited ease of use as a primary reason for investing in equity ETFs, while 80% said they invested in ETFs because of the speed with which they could execute trades to gain diversified exposures. More than three-quarters cited liquidity, and more than two-thirds cited market access, low trading costs and/or attractive management fees, as primary reasons for using ETFs.

Such benefits prompted more than a quarter of institutional investors surveyed to state they are planning to increase their ETF holdings in the next 12 months.

Institutional investors have been able to realize such benefits across a wider range of applications, both strategic and tactical, than ever before. Two of the top three institutional uses of ETFs – international diversification, cited by 71% of respondents, and core allocation, cited by 55% – are strategic in nature.

Institutions continue to use the funds for tactical applications, including portfolio adjustments (68%), rebalancing (47%), transition management (34%) and interim beta (21%). But they have also made 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/overlay strategies.

While Canadian institutional ETF use is most mature in equities, the survey revealed they are also taking greater advantage of the diversity of asset classes today’s ETF marketplace offers. For instance, more than 15% of ETF investors used commodity ETFs, and close to 20% used ETFs tracking real estate income trusts (REITs).

However, fixed income ETFs have seen the greatest increase in institutional investor demand in recent years. According to Greenwich Associates, close to two-thirds of institutional users invest in bond funds, including more than three-quarters of asset managers and insurance companies.

Canadian institutions also relied on fixed-income ETFs more than their counterparts in other countries. On average, Canadian institutional ETF users invested about a quarter (26%) of total fixed-income assets in bond ETFs – more than three times the average allocation among counterpart European institutions. Insurance companies in particular held approximately 35% of fixed income assets in ETFs.

Why are institutions turning to bond ETFs? The reasons varied, from ease-of-use and single-trade diversification (cited by 71% of respondents) to low management fees (67%) and trading costs compared to cash bonds (52%). The prime motivator for using fixed-income ETFs, however, was liquidity, cited by more than 80% of respondents.

According to Greenwich Associates, Canadian institutions have not experienced fixed income liquidity constraints to the same extent as their European and US counterparts have, but the global landscape is clearly shifting in response to new, post-crisis bank capital requirements. Despite their already high level of bond ETF use, continuing concerns over liquidity could well drive even further adoption by Canadian institutions – many of which have been exposed to liquidity constraints when investing in international fixed income.

Smart beta ETFs were also flagged by the report as growing in popularity as investors, faced with an ongoing low-rate environment, continued to look beyond traditional securities for returns. Nearly a third (31%) of surveyed institutions invested in these funds – a level of smart beta use that places higher than Europe but just below the US. Furthermore, more than half of smart beta ETF users plan to increase their allocations to these funds in the next year.

The report found that the mix of Canadian institutional use of smart betas has evolved. As in last year’s survey, multi-factor ETFs continued to be popular, used by half of smart beta ETF investors. Notably, however, half of smart beta investors held dividend/equity-income ETFs, a significant number considering no investors in last year’s survey were using dividend ETFs at all.

“The results of this year’s Greenwich Associates study reflect the major trends that we see in our work with institutional investors on the ground,” said Collier. “On the one hand, institutions are becoming more familiar with the ever-growing range of ETF solutions available to them. On the other, institutional investors are continually finding new and sophisticated ways to apply those solutions, both in response to market forces and to express their strategic views. In an ever-changing investment environment, we expect those trends to continue going forward.”

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