Institutional investors are increasingly recognizing the benefits of adding exchange-traded funds to their portfolios and are flocking to these diverse, index-linked investment vehicles in droves. A 2014 study from Greenwich Associates found that the share of institutions using ETFs has increased in each of the past five years, and this trend is expected to continue. Nearly half of institutional ETF users now allocate more than 10% of their total assets to ETFs.
Through February 2015, bond ETFs took in more than $32 billion in assets globally this year, in what has been the strongest start to any year since their introduction in 2002. More than half of those assets – nearly $20 billion – came from institutions such as insurers and endowments, and in some larger funds, institutional investments have more than doubled in the past few years.
In fact, the $2.6 trillion ETF market is projected to reach $5 trillion by 2020, according to “ETF2020: Preparing for a New Horizon”, a recent report from PricewaterhouseCoopers, as institutions realize the value of these instruments. While the entire category has experienced a marked increase in capital inflows, fixed-income ETFs are showing particularly high levels of momentum.
With intra-day liquidity, a favorable tax structure, and low operating expenses, institutions are increasingly turning to ETFs as primary investment vehicles, taking advantage of their single point of entry and wide range of options enabling them to gain exposure to – or hedge – a variety of markets at a much lower cost per share.
Above all, ETFs provide flexibility and diversification. Innovation within the category provides investors with the opportunity to take advantage of an ever-growing variety of both traditional securities and evolving asset classes as the industry continues its expansion. Today investors can easily access alternative investing strategies with liquidity unavailable in the hedge-fund industry.
Uncertainty in the markets has also driven growth. Financial professionals are examining how to best incorporate ETFs into their portfolios as Federal Reserve policy makers consider when to raise interest rates, international events roil markets, and the S&P 500 approaches an unprecedented seventh year of gains. Some in the financial world are particularly wary of the stock market’s advance. Yale University professor Robert Shiller noted in recent research that U.S. equities have never advanced seven consecutive years in a row.
Changing market conditions have always been key growth drivers for ETFs. For example, ETFs have increasingly become a more attractive way for investors to access derivatives markets as increased government oversight and slashed bank trading operations push costs higher. According to a 2014 Russell Investments report, BlackRock said that it had seen $2 billion of inflows from investors who have chosen ETFs over futures and swaps.
In addition to being an efficient way to access alternative assets, investors are more often relying on fixed-income ETFs to mitigate volatility and gain access to diverse bond portfolios without the cost and complexity of conducting multiple transactions to achieve the desired level of exposure to a particular basket of assets.
Recent bond market trends have also been a boon for fixed-income ETFs. Despite a record amount of new issues, recently implemented regulations have led to limited dealer inventories, driving trading volumes and liquidity lower for individual bonds. At the same time, liquidity in bond ETFs has increased rapidly, setting in motion a period of hyper-growth for fixed-income ETF trading volumes, which have risen more than 800 percent since the start of the 2008 financial crisis.
Another group to benefit from the growing array of ETF options are so-called “smart beta” investors looking for alternatives to market-capitalization weightings. They have also found ETFs to be fertile ground for implementing their strategies, currently holding about 20 percent of all U.S. ETF assets, according to Bloomberg Markets.
With significant advantages in the critical areas of cost efficiency and innovation - and few drawbacks for investors - ETFs are likely to take in more institutional funds for years to come and be a go-to source for a growing network of investors.
Eric Ervin is President and CEO of Reality Shares, Inc. This article expresses his opinions and may not necessarily represent the opinions of Reality Shares. This material does not constitute an offer to buy or sell any investment product.
Eric Ervin is a Registered Representative of ALPS Distributors, Inc.
The views and opinions expressed in this article are those of the author and do not reflect the official position of WealthManagement.com.