Investors have a differentiated view on ETF replication methods, according to EDHEC-Risk Institute’s annual European ETF Survey of European ETF investors.
A majority of respondents to EDHEC-Risk Institute's annual ETF survey indicated that they intend to increase their allocation to ETFs in the future.
In general, respondents prefer full physical replication over either sampling replication (where the index is replicated physically with a select representative sample of securities) or swap-based synthetic replication.
However, there is a clear preference for synthetic ETFs to replicate indices in challenging universes, such as illiquid alternative asset classes and broad indices with more than 1,000 constituents.
Overall, in terms of reliability, coverage, cost and risk, all three approaches are comparable, though synthetic replication actually receives a slightly higher average rating compared to full replication and sampling replication.
While investors are using ETFs more heavily for dynamic strategies and specific sub-segment exposure than in the past, the main use of ETFs remains long-term buy-and-hold investing in broad market indices.
Investors are also moving towards applying ETFs for portfolio optimisation and risk management, and continue to see ETFs mainly as index-replicating products, rather than active funds.
ETFs are mainly used as beta or asset allocation tools, thus allowing investors to focus on the first-order issue of beta management, rather than on stock picking issues, which are only of third-order importance.
There has been increasing demand for ETFs based on new forms of indices, from 29% to 39% over the past year, which indicates growing interest in alternative-weighted indices.
Interestingly, the survey suggests that industry communication on the risks of ETFs has led to the counterparty risk of physical ETFs being underestimated. As a consequence, investors think that full physical replication is less risky in terms of counterparty risk than synthetic replication, even though almost all physical replication ETFs engage in securities lending, something which synthetic providers typically avoid.
In terms of future use, a majority of respondents (63%) indicate that they intend to increase their allocation to ETFs in the future.