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In Good Company – Institutional ETF Usage Trends

Taken from isharesblog.com

A new report finds that more and more institutional investors are making ETFs part of their portfolio strategy, and that’s good news for retail investors.

With many financial innovations, institutional investors are often the first in; they hear about the innovations early, or they quickly figure out ways to use them. Later the retail investors follow.

ETFs, however, have shown a slightly different pattern. After 1993, when the first ETF was introduced in this country, ETFs were primarily of interest to institutional investors. At first, their main use was as a place to hold cash before investing in a new asset class, but institutions soon began using them for other purposes, such as tactical allocations and hedges.

In the past decade or so, retail investors overwhelmingly became the most frequent ETF purchasers. Many retail investors bought ETFs after feeling burned by the bursting technology bubble of a decade ago, likely because they learned that diversification in a portfolio can be beneficial.  But now we’re seeing the trend come full circle: According to a just-released report by financial research firm Greenwich Associates, “institutional investors are increasingly bullish” on using ETFs in their portfolios.  Greenwich interviewed 45 institutional funds, including corporate pensions, public pensions, endowments and foundations, about their interest in ETFs; they also interviewed 25 large asset management firms in the U.S.

The results? Forty-eight percent of asset management firms interviewed planned to increase their portfolio exposure between now and 2013, and none planned to decrease it. And though current ETF holdings are small relative to the total of funds these firms have under management, they constitute about half of ETF assets invested nationwide.

What’s causing the growth of institutional investment in ETFs?   A primary reason is that institutional investors have developed or simply come to appreciate additional ways in which ETFs can support and strengthen their overall portfolio strategy. The firms are still using ETFs for cash equitization (a place to put cash that’s in transition rather than keeping large amounts out of the market); and they’re also still using ETFs as an interim strategy during a shift from one fund manager to another.

But, the Greenwich report says, institutional investors are doing much more with ETFs, including using them for hedges or to acquire exposure to asset classes that aren’t always easy to access, and for the sake of liquidity.

Why is this good for retail investors?  Because many large pension funds are managing money on behalf of millions of individual investors, who are in turn exposed to the benefits that ETFs provide, including relatively low cost, tax efficiency, and transparency. 

Diversification may not protect against market risk.

There can be no assurance that an active trading market for shares of an ETF will develop or be maintained.

Transactions in shares of ETFs  will result in brokerage commissions and will generate tax consequences. ETFs are obliged to distribute portfolio gains to shareholders. 

Neither SEI, and its affiliates, nor BlackRock Institutional Trust Company, N.A., and its affiliates, are affiliated with Greenwich Associates.