The University of Connecticut’s endowment shifting away from hedge funds toward exchange-traded funds is part of a larger trend of investors embracing the liquidity, transparency, and lower fees of ETFs to lower their risks.
David Ford, UConn Foundation’s investment chair, said the $634 million endowment sold most of its hedge fund holdings last fiscal year, and replaced them with buffer ETFs, which use options to protect against losses while capping upside gains.
Ford told Bloomberg that buffer ETFs are cheap and liquid.
“This takes the complexity out of hedging, or most of the complexity,” Ford said. “Instead of having to go to an institutional desk and say, we want to design the following options trade, it’s already prepackaged and trading.”
The move from UConn comes at a time when the ETF industry has crossed $1 trillion in inflows, thanks in part to institutions.
“For smaller institutional investment teams with limited experience, ETFs offer a professionally easier way and easier alternative to mitigate portfolio volatility,” Jordan Rizzuto, CIO at GammaRoad Capital Partners, told Institutional Investor.
Cerulli Associates found that 37 percent of institutional investors are planning to increase their allocations to ETFs over the next two years. Cost reduction remains a significant driver of the trend, particularly among insurance general accounts, where a net 40 percent expect to allocate more to ETFs and a net 25 percent anticipate reducing traditional mutual fund holdings.
While ETFs are already widely adopted — 80 percent of institutional investors use them — only 16 percent use ETFs as core holdings. Instead, most institutions employ them for specific purposes. More than half (51 percent) use ETFs to gain or maintain exposures, 34 percent for cash management, and 27 percent for tactical bets.
“The most common use cases for ETFs suggest that institutions are not holding their positions for an extended period, as they would for other mandates,” said Jack Tamposi, associate director at Cerulli. “Institutions indicate that they use the vehicle as a transition tool, managing exposures to asset classes, rather than as a long-term, core investment holding.”
Passive equity ETFs dominate institutional portfolios, with at least 76 percent of investors across channels employing them. Active equity and passive fixed-income ETFs are each used by 78 percent of insurers; active fixed-income ETFs lag, with only 35 percent of foundations, for example, adopting them. A shortage of products with established track records has dampened broader adoption of fixed-income ETFs.
While ETFs are cheaper, more transparent, and more liquid than hedge funds, there’s another aspect that appeals to investment committees: They require less in-house expertise. Traditional hedge fund investments are complex and require a well-equipped, experienced team of institutional experts to effectively manage — something that smaller endowments like UConn’s often lack.
“Many E&Fs are staffed lean. They might lack due diligence experience or implementation experience in evaluating and allocating to hedge funds,” Rizzuto said. He added that using hedge funds to mitigate volatility “can still make sense … for larger investors that have the professional bench depth to run the analysis and due diligence.”
Cerulli anticipates that institutions will increasingly view ETFs as long-term holdings as they shift risk budgets toward alternative strategies like private markets. “To win mandates, asset managers must align not only with in-demand strategies but also with the vehicles institutions prefer for implementing them,” Tamposi added.