Product breadth and liquidity attract institutional investors to ETFs, says Moody’s

Sep 19th, 2013 | By | Category: ETF and Index News

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Institutional demand for exchange-traded funds (ETFs) has increased markedly in recent years, fuelling rapid growth of a product originally geared towards retail investment, according to a report from Moody’s Investors Service.

Product breadth and liquidity attracts institutional investors to ETFs, says Moody’s

Moody’s notes that ETFs are attracting flows that once would have gone into traditional mutual funds, futures and swaps.

While still only a small portion – approximately 10% – of the overall US mutual fund sector, ETFs have grown rapidly.

During the five-year period beginning with the credit cycle peak of 2007, total US ETF assets have grown at a compound annual growth rate of 17.07%.

“ETFs are increasingly attracting flows that once would have gone into traditional mutual funds or to hedging vehicles such as futures and swaps,” said Moody’s Vice President Stephen Tu, the author of the report.

Tu added: “This institutional participation will likely continue to expand, which is a credit positive for large ETF providers such as BlackRock [parent of iShares], State Street [parent of SPDR ETFs] and Invesco [parent of PowerShares].”

While institutional investors initially used ETFs for simple investment functions such as temporarily investing cash, growing product diversity has led them to use ETFs in other areas, says the rating agency.

Moody’s notes that institutional investors – including even traditional mutual fund managers – now hold over half of all US ETF shares. For example, institutional investors own 85.5% of the outstanding shares in the SPDR S&P 500 ETF (SPY), the world’s largest ETF by assets under management.

In addition, as liquidity has increased, ETFs have become hedging tools used by sophisticated investors for shorting or tail hedging. Investors are also starting to use ETFs in order to gain access to esoteric markets, or to have access to assets in markets that have been closed or are constrained due to regulation.

The report chimes with a recent study from Greenwich Associates, which showed that half of institutions using ETFs expect to increase their allocations to ETFs in the coming year and that usage of the products was evolving.

The Greenwich study noted that ETFs first entered institutional portfolios mainly as tactical tools, but were increasingly being used as vehicles for gaining long-term exposures and implementing core investment strategies.

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