Almost from the very moment that ETFs arrived on the scene, they have been lauded for the ease and speed with which they can be used, as well as for their exceptional flexibility. The ETF growth story over the years has been fueled in large part by the consistent emergence of new ways to use them. According to a new global survey of 766 institutional investment decision makers at insurers, endowments, family offices, foundations, pensions, and asset management firms, that remains the case.
The survey, Managing Market Volatility in 2021: What institutional investors did in 2020 – and what they learned, was conducted by Institutional Investor in Q3 2020, meaning participants had had ample time to consider how they used ETFs during the heightened volatility that followed quickly on the heels of Covid-19 as it swept the globe.
Broadly speaking, survey respondents said they frequently use ETFs for liquidity management and tactical portfolio solutions. Using ETFs during manager transitions is seen as a way to potentially “reduce portfolio performance drag,” according to one investment decision maker interviewed in conjunction with the survey. How ETFs are deployed in some specific strategies by specific types of investors is also revealed in the survey. For example, 73%1 of insurance companies and pensions in the survey use ETFs in their liability-driven investment (LDI) strategies.
Liquidity management, transition management, and tactical adjustments are the top reasons investors use ETFs
Here’s a closer look at three important traits of ETFs the Institutional Investor survey shines a light on.
Liquidity management: A majority of respondents (52%)2 use ETFs to manage liquidity. Fixed income ETFs were cited by 83%3 of respondents as being especially well suited for liquidity management applications.
One senior analyst interviewed during the survey pointed to an example of how the liquidity of fixed income ETFs enables an interesting use case. “Maybe we have a manager that’s doing significantly better than we think is a reasonable expectation based on how they invest,” said the analyst, based on his experience at an asset management firm. “We could trim from that manager and put some of that into an ETF temporarily while we wait for some performance reversion from the manager. We do that quite often.”
- Transition management: 70%4 of respondents use ETFs when moving from one manager to another. A majority of those using ETFs during manager transitions see fixed income (74%) and equity (51%) ETFs as especially suitable for that scenario.
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“Often, if you sell out of a manager and go to cash or some other transitional vehicle, there’s a lot of risk. When you park it in an ETF, it minimizes performance drag and it’s a very smooth transition from an asset class perspective,” said a portfolio manager interviewed as part of the survey.
- Tactical adjustments: 61%6 of survey respondents use ETFs to make tactical portfolio adjustments. Such respondents are most likely to use fixed income (66%) and equity (57%) ETFs for tactical adjustments.
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“If we’re going into a market where they may have a home bias, ETFs are helpful,” said another portfolio manager who was interviewed. “There’s a lot of regulation outside the U.S., particularly in Asia, around the amount you can invest in underlying funds. When we see we’re reaching those caps, we’ll put an ETF alongside one of our active strategies so we’re not violating regulations and maximum allocations.”
Another situation in which institutional investors use ETFs – specifically, fixed income ETFs – is during the portfolio rebalancing process. In that scenario, investors prefer to use fixed income ETFs (41%) rather than individual bonds (28%).8
According to Frans Scheepers, Managing Director, Indices, at IHS Markit, “Index-based products – for example, ETFs like LQD and HYG – have been critical in enabling institutional investors to rebalance their portfolios tracking our fixed income indices. Low transaction costs and depth in liquidity have helped investment managers to minimize performance drag during periods of transition.”
Given the manner in which fixed income ETFs were used when the market was most stressed at the start of the pandemic, it’s possible their use during market volatility may increase over time as institutional investors become more comfortable with the funds in challenging scenarios. This is noteworthy, as 68% of respondents in the survey indicated a likelihood that they would reposition their portfolios for continued heightened volatility.
1 Of 264 respondents.
2 Of 762 respondents.
3 Of 394 respondents.
4 Of 762 respondents.
5 Of 534 respondents.
6 Of 762 respondents.
7 Of 468 respondents.
8 Of 759 respondents.
FOR U.S. INSTITUTIONAL INVESTOR USE ONLY.
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Investing involves risk, including possible loss of principal.
Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments. Non-investment-grade debt securities (high-yield/junk bonds) may be subject to greater market fluctuations, risk of default or loss of income and principal than higher-rated securities.
International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks often are heightened for investments in emerging/developing markets and in concentrations of single countries. Funds that concentrate investments in specific industries, sectors, markets or asset classes may underperform or be more volatile than other industries, sectors, markets or asset classes and the general securities market.
Transactions in shares of ETFs may result in brokerage commissions and will generate tax consequences. All regulated investment companies are obliged to distribute portfolio gains to shareholders. There can be no assurance that an active trading market for shares of an ETF will develop or be maintained.
Shares of ETFs may be bought and sold throughout the day on the exchange through any brokerage account. Shares are not individually redeemable from an ETF, however, shares may be redeemed directly from an ETF by Authorized Participants, in very large creation/redemption units.
This information should not be relied upon as research, investment advice, or a recommendation regarding any products, strategies, or any security in particular. This material is strictly for illustrative, educational, or informational purposes and is subject to change.
The iShares and BlackRock Funds are distributed by BlackRock Investments, LLC (together with its affiliates, “BlackRock”).
This study was sponsored by BlackRock. BlackRock is not affiliated with Institutional Investor or any of their affiliates.
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