The onset of the global COVID-19 pandemic in early 2020 saw institutional investors increasingly turn to ETFs to solve unexpected challenges, according to a new global survey, Managing Market Volatility in 2021: What institutional investors did in 2020 – and what they learned, conducted by Institutional Investor. Of particular note during the most volatile days early in the pandemic was institutional investors’ use of fixed income ETFs when liquidity, price discovery, usage, and transaction costs were pressure points across multiple areas of the bond market – including high yield, investment-grade corporate, emerging markets, and, for a short time, U.S. Treasuries.
It’s worth noting that the timing (Q3 2020) of the survey of 766 institutional investment decision makers at insurers, endowments, family offices, foundations, pensions, and asset management firms means that respondents had been through the worst of the initial disruption caused by the pandemic. This allowed their answers to reflect on both how their portfolios performed in the crunch and how they might plan for the next few years.
Elevated volatility expected to continue
As they look to the next 18 months, 68% of all institutional investors in the survey expect continued heightened volatility, and 65% plan on increasing their use of ETFs – the highest percentage anticipated increase in use of any investment vehicle. Expectations of increased use of ETFs going forward are likely based in large part on how institutional investors used them during the early period of pandemic-related market dislocation.
During that time, fixed income ETFs in particular proved extremely flexible and valuable when 95% of all respondents to the Institutional Investor survey said they had difficulty sourcing new bonds, and that individual bond transactions were also a pain point (92%). In response to these challenges, investors said their organizations increased use of fixed income ETFs as a means to source and price bonds and to execute trades (54%).1 ETFs were a good replacement for individual bonds, according to respondents, because they are liquid (61%)2 and they provide quick market exposure and access (55%).3
“Early in the pandemic, bond markets experienced unprecedented volatility, dislocation, and challenges in liquidity. During the worst of the market turmoil in February and March 2020, we saw fixed income indices become central to the decision-making process for a growing number of institutional investors. Indices such as CDX, and index-based ETFs such as LQD and HYG, remained highly liquid and played an important role in providing price discovery to the market. We continue to see increased demand in portfolio construction as a quick way for investment managers to get their beta4 exposure in addition to cash and liquidity management,” said Frans Scheepers, Managing Director, Indices, IHS Markit.
At the outset of pandemic-related financial stress, trading in U.S. fixed income ETFs surged to $1.3 trillion in the first quarter of 2020 – half of the $2.6 trillion for all of 2019.5 In many cases, institutional investors found ETFs provided more liquidity, greater transparency, and lower transaction costs than the underlying bond market.
“Toward the end of 2019, using ETFs to implement our credit strategy in investment-grade and conservative duration and risk positions became a more viable option for us. I spent a lot of time getting comfortable with the risks and liquidity of ETFs,” said one portfolio manager who took part in the survey. “The early months of the pandemic presented some case studies in how they reacted in a less than ideal liquidity environment. Coming out of that, we have significant balances to invest in that bucket of the portfolio – cash and, in the medium term, fixed income. That’s where we see the most opportunity to expand our ETF usage going forward.”
ETFs also key tool in rebalancing portfolios
Ninety percent of all respondents to the Institutional Investor global survey rebalanced their portfolios within six months of the onset of pandemic-related volatility. That in itself isn’t especially unexpected – there’s nothing like a severe shock to reveal where a portfolio has strayed from its intentions, perhaps having taken on more unpaid risk or excess correlation than realized.
More revealing, however, was the extent to which investors rely on ETFs during the rebalancing process. The survey found that 70%6 of investors use ETFs when attempting to get their asset mix back in line with their investment guidelines. That percentage far outpaced the next two preferred methods of rebalancing, namely use of mutual funds and derivatives, both at 51%.7
1 Of 762 respondents
2 Of 671 respondents
3 Of 671 respondents
4 Beta is the return generated from a portfolio that can be attributed to overall market returns.
5 BlackRock, Bloomberg (as of May 31, 2020)
6 Of 692 respondents
7 Of 692 respondents. The question asked respondents to select all that applied among ETFs, mutual funds, derivatives, commingled pooled funds, individual fixed income and equities securities, and increased cash position.
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