US institutional investors increased their exposure to exchange-traded funds (ETFs) in 2018, driven by a higher focus on risk management, making them the global leaders in ETF investing, according to a new report from US-based analytical firm Greenwich Associates.
The survey of institutional investors that invest in ETFs reveals the average allocation among investors in 2018 was 24.8 percent – up from 18.5 percent in 2017. The report notes that growth was driven by a desire to emphasize risk management, with 70 percent of respondents citing ‘managing risk/return that is in line with objectives/outcome’ as a top priority.
‘In the US, we saw a significant pick-up last year in institutional use of ETFs as investors readjusted their portfolios for resilience in the face of market volatility,’ says Greenwich Associates managing director Andrew McCollum in a statement.
Looking at the trends in more depth, the strong growth was driven in large part by three powerful trends, says the report, affecting institutional portfolios and portfolio construction:
- Turbulence drives demand: A confluence of events ranging from interest-rate hikes and fears of recession to trade wars and Brexit had institutions laser-focused on risk management in 2018. As they repositioned their portfolios to address these risks, many US institutions used ETFs to implement specific changes. Study participants say they chose ETFs for an ease of use that allowed them to quickly and seamlessly integrate new exposures into strategies across portfolios and asset classes, and to take advantage of other characteristics such as speed of execution, single-trade diversification and liquidity
- The index revolution proceeds: US institutions continued shifting assets from active management to index strategies, and 78 percent of study participants name ETFs as their preferred vehicle for index exposure. As ETFs displace other investment vehicles in institutional portfolios, active mutual funds are by far the most common vehicles being replaced. This transition should fuel additional demand for ETFs as institutions continue shifting assets to index strategies
- Proliferation across portfolios: Institutional investors continue expanding the list of portfolio functions in which they are applying ETFs. The spread of ETFs is being fueled in large part by versatility that allows them to serve a broad range of strategic and tactical purposes, and by their role as institutions’ preferred vehicle for factor-based/smart beta and other specialized exposures. In future, institutions’ integration of ESG principles into their portfolios and investment processes could give a further boost to ETF demand.
The top risk expected in 2019 by respondents that invest in ETFs is geopolitical events at 64 percent, while 63 percent cite the end of the economic cycle/recession and central bank tightening.
Of those who see geopolitical events as a top risk, 86 percent express concern about trade wars, while 40 percent cite the China debt crisis, 39 percent the fragmentation of the European Union and 36 percent the increase of populism.
Respondents say they allocate about 45 percent of total equity assets to index strategies, and 40 percent of those respondents say they are actually targeting an allocation of more than 50 percent of their total equity assets to indexing.
In fixed income, meanwhile, respondents say they allocate about 28 percent of total fixed-income assets to index strategies, with 30 percent of those investors allocating 50 percent or more to index strategies.
‘Although it’s unclear whether ETFs can sustain last year’s rapid pace of expansion, we expect the growing list of uses and overall assets invested to continue to grow in 2019, as more than 40 percent of equity and bond ETF investors in the study plan to increase ETF allocations in the year ahead,’ adds McCollum.
