Allocators Increase ETF Use to Diversify Exposures

The proliferation of and innovation in exchange-traded-fund products has expanded how institutional investors use ETFs.

“A key feature of ETFs is that they are daily liquid, offer transparency of holdings, allow for smaller trade sizes and are often quite cost effective,” says Paisley Nardini, managing director and head of multi-asset solutions at Simplify Asset Management. “A key benefit for asset owners [who] wish to tactically take advantage of price dislocations or momentum is that they can gain exposure intra-day as prices may be moving rapidly.”

Dave Abner, global head of ETFs at Northern Trust Asset Management, notes that institutional investors are using more ETFs in general.

“They are finding them way more convenient for their portfolios,” Abner says. “Their pricing has come down, where they are competitive to the traditional vehicles that [institutional investors] used to use.”

These investors have primarily used ETFs for two main uses, according to Kelly Cavagnaro, the managing director and head of the North America institutional client group at Janus Henderson, who says that ETF growth has been slower among institutional investors than in other channels, but is picking up. The first use case includes tactical asset allocation.

“ETFs, certainly due to their liquidity and trading structure, can enable investors to capitalize on [a] second-by-second price move in the market, compared to other products that can be traded exclusively at market close or sometimes even less frequently than that,” Cavagnaro says. “ETFs are super helpful tools for institutional investors to make those tactical portfolio adjustments and implement their views with efficiency.”

Cavagnaro notes that ETFs help investors capitalize on short-term market opportunities and mitigate risks.

A second historical use case is using ETFs for transition management—maintaining market exposure during manager transitions between funding more intentional market exposures.

“Those low transaction costs, high liquidity [and] operational simplicity make ETFs a super attractive vehicle during restructuring,” Cavagnaro says.

New Asset Classes and Strategies

Cavagnaro and Daniel Aronson, an ETF product specialist at Janus Henderson, note that institutional investors also are starting to use ETFs for newer, more strategic uses.

“A lot of where we’ve seen institutions engaging us is … getting exposure to places that maybe otherwise didn’t exist,” Aronson says. This includes niche strategies and newer asset classes like bitcoin and other cryptocurrency-based ETFs.

“One of the things we’ve also had a pickup in conversations around is this idea of a management of a portfolio of ETFs within an individual sleeve or a separately managed account, either managed by in-house teams or another manager to whom they give discretion,” Cavagnaro says. “It’s becoming a more accepted and creative way to manage and maintain the benefits of ETFs—liquidity, transactional cost savings, operational simplicity—while enabling the investor to implement a much more customized strategy based on the individualized goals and objectives of each one of the individual institutional investors.”

Institutional investors are also using ETFs to gain exposure to different factor tilts. A report from BlackRock noted that active managers that tilt to different factor weights can generate alpha by harnessing cyclicality—something the firm aims to do with its DYNF ETF.

“A lot of institutional investors use ETFs to tilt toward the hottest part of the market: They use ETFs to hedge or hedge views against a market,” says Eric Croak, the president of Croak Capital. “In this sense, ETFs are the purest form of an active investment.”

The vast number of ETFs—about 5,000—and the number of publicly listed stocks mean there is a fund or theme for every investor.

“ETFs allow investors to be as broad as they want, but also as [narrow] as they want,” says Aram Babikian, head of ETF sales at the DWS Group, formerly Deutsche Asset Management. “If an investor wants to de-risk their portfolio for geopolitics, there is an ETF for that. If investors want to strictly invest in the [artificial intelligence] theme, there is an ETF for that.”

Croak notes that ETFs can be overweight or underweight different sectors, factors and countries, allowing institutional investors to “flex” without capital efficiency as they invest in ETFs.

“In this sense, ETFs have been used as a strategic tilt to alter exposures without the capital inefficiency that comes with liquidating or buying into an underlying asset directly,” Croak says. “The liquidity and ability to trade ETFs as easily as they trade individual stocks has made ETFs the new language for tactical tilting.”

Another key benefit of some ETFs is that asset owners can now trade in-kind or take receipt of the underlying asset (crypto and/or gold). “This gives ETFs another added benefit of flexibility so that allocators can accommodate unique investor needs,” Nardini says.

That flexibility is one reason ETFs continue to gain ground.

“Even the traditional institutional investors really have seen the benefits of using an ETF versus some of the other methods they could get exposure, especially in commodities,” says Robert Minter, Aberdeen Investments’ director of investment strategy.