European Institutions Keen on ETFs

Terry Flanagan

Institutions in Europe have adopted exchange-traded funds faster than those in the North America and and use ETFs at a higher rate according to consultancy Greenwich Associates.

The “Greenwich Associates 2014 Continental European Investment Management Study” found that 25% of European institutions used ETFs in their portfolios, about the same as in 2011, when 24% reported using ETFs. In the US, 14% of institutions were using ETFs in 2011 and that has grown to around 20% today.

The consultancy interviewed 120 European-based institutional investors in the third quarter of last year, 83 of whom use ETFs. The respondents included 68 pension funds, 30 asset managers and 22 insurance companies.

One pension fund executive told Greenwich Associates the scheme used ETFs for two reasons. “One was to get country exposure in areas where it was difficult to invest directly. The second reason was to cover short-term liquidity problems, so for instance if we had cash just sitting there, we would use an equity exposure quite quickly,” the executive added.

The survey found that institutions invest in ETFs because of their ease of use, efficient market access and liquidity. Greenwich said: “Thanks largely to this flexibility, ETFs have become a mainstay in European institutional equity portfolios, and they are fast gaining traction in fixed income.”

Most pension funds had ETF allocations of between 1% and 10%, but a fifth allocated between 11% and 25% of total assets. Fund managers allocated an average of 11% of total assets to ETFs but nearly a tenth allocated more than a quarter of total assets.

The study said: “More than half the asset managers in the study- 54%- say they are ‘likely’ or ‘very likely’ to manage an ETF-only product (mutual fund, managed account, unit-linked, etc.) at some time in the future. This finding suggests that many asset managers are adopting ETFs as a tool in product development.”

More than half, 60%, of institutions said ETFs are replacing futures, index funds or more expensive actively managed funds. One pension fund representative told Greenwich that his institution had used ETFs to replace unit and investment trusts “on the grounds of liquidity and cost.”

In the next three years 22% of institutions expect to increase their ETF allocations with about a tenth raising their allocations by more than 10%.

Greenwich Associates said: “The actual rate of growth could even surpass the levels suggested by these reported expectations as European institutions alter their portfolios and investment practices. Many institutions – particularly those on the Continent – are diversifying their portfolios away from the European government bonds that traditionally made up the bulk of their assets.”

The PwC report, “ETF 2020: Preparing for a new horizon”, said institutional investors are widely expected to be the primary growth driver for ETFs in coming years, particularly insurance companies, pension plans and hedge funds.

One asset manager told PwC: “ETFs continue to take market share away from other products, and firms will either have to launch ETFs or create other investment vehicles which are competitive with the performance, tax efficiency, and costs of ETFs.”

PwC warned that some managers may feel forced to introduce new ETF products cannibalise some existing funds. Another survey participant said: “It is necessary to consider the profit model and how to deal with losses before product launch. Operating costs are high and ETFs do not necessarily generate returns in the short term.”

In  Europe, PwC said the distribution landscape is being reshaped by regulation such as MiFID II and the UK’s Retail Distribution Review which will drive increased use of ETFs.

“They are promoting the ongoing digitisation of financial advice,” added PwC. “With their specific, liquid, cost-effective exposure to virtually any asset class, ETFs are perfectly suited to new online advice platforms and apps that are emerging from the shadows of traditional intermediaries facing greater regulation.”

However the study found that inefficiencies in the trading of ETFs trade and the fragmented market in Europe, with ETFs having to list and settle on multiple national exchanges, are holding back growth.

“In the future, it is anticipated that managers will look to launch cross-border European ETFs with centralised settlement,”added PwC. “This move would enable ETFs to be traded on any exchange in Europe, but be settled centrally, which would be similar to the U.S. systems where trades are settled centrally.”

Euroclear Bank, the international central securities depositary, has been pioneering as international ETF structure in Europe to allow more efficient cross-border settlement. Market participants can settle their trades through Euroclear rather than having accounts with multiple national central securities depositories to move ETFs between countries.

Last month Pimco issued the first actively managed fixed income ETF using Euroclear’s international structure. This followed State Street Global Advisors becoming the first issuer to migrate ETFs from a domestic structure to an international structure and BlackRock listing an iShares ETF with an international structure.

PwC surveyed executives from approximately 60 firms around the world in 2014 using a combination of structured questionnaires and in-depth interviews. Two-thirds of the participants were ETF managers or sponsors, with the remaining participants divided between asset managers not currently offering ETFs and service providers. Participating firms account for more than 70% of global ETF assets.

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