Institutional use of exchange-traded funds (ETFs) is climbing as institutional investors adopt ETFs both as an everyday tool in routine portfolio functions and as a means of obtaining long-term strategic investment exposures.

Institutions such as CalPERS, one of the largest pension funds in the US, are increasingly integrating ETFs into their everyday investment toolkits. (Photo © Copyright 2014 CalPERS)

That’s according to the latest installment of an annual survey of US institutions conducted Greenwich Associates, a research-based financial services consultancy.

Commissioned by BlackRock, the parent of iShares, the study suggests that ETFs are now being integrated into institutional investors’ standard toolkits. And whilst the analysis focuses on the US institutional market, similar trends are emerging in Europe.

The study identifies several important developments:

• The share of US institutions using ETFs has increased in each of the past five years and is expected to rise in the coming year.
• Nearly half of institutional ETF users now allocate more than 10% of total assets to ETFs.
• ETFs are gaining traction in asset classes outside equities, especially in fixed income, where changes in market structure could boost ETF use. The share of institutional users employing ETFs in domestic fixed income increased to two-thirds in 2014 from just 55% in 2013. Another 35% of institutions overall are utilizing ETFs for international fixed-income access, up from 29% last year. Forty percent of the institutional ETF users employ the vehicles in commodities, and 45% are using ETFs in REITS.
• ETF holding periods are lengthening. The share of institutions reporting average holding periods of two years or longer jumped to 49% in 2014 from 36% in 2013.
• A growing number of institutions are using ETFs to obtain strategic investment exposures. In 2014, approximately 80% of participating institutions using ETFs are employing them as a means of obtaining core portfolio exposures—making it the most common ETF application among study participants. That share is up from 74% using ETFs for this task in 2013.

Consistent growth, broader applications 

As recently as 2011, fewer than 15% of US institutions were using ETFs in their portfolios. That share climbed to 18% in 2012 and reached 21% in 2013, according to data collected in Greenwich Associates. Those overall averages understate the extent to which ETFs are used by certain types of investors. For example, 40% of US endowments employ ETFs in their portfolios, as do one third of the largest public defined-benefit pension funds (those with at least $5 billion in AUM) and roughly 25% of the largest corporate defined-benefit funds.

Although ETFs represent a small percentage of total US institutional assets, some institutions have begun building sizable ETF allocations. Forty-six percent of institutional ETF users participating in the latest study allocate 10% or more of their total assets to ETFs, with almost three in 10 reporting ETF allocations from 10% to 25% and nearly one in five institutions making even greater allocations.

The results of the study suggest ETFs will continue to gain momentum in the coming year. Among institutions currently employing ETFs in their portfolios, nearly half say they expect to expand use in the next year. One third of the institutions in the 2014 study expect to grow allocations by 1%-10%, while nearly 15% plan to increase by 10% or more.

“What we’re seeing is a broadening of ETF use,” says Greenwich Associates consultant Andrew McCollum. “Institutions are finding that ETFs are an effective tool for implementing their portfolio strategies and obtaining core exposures, while at the same time they are continuing their use for the tactical applications in which many investors were first introduced to ETFs.”