Institutional Investors’ New View of ETFs

As exchange-traded funds become a larger part of institutional portfolios, some investors are taking adoption one step further, working with asset managers to bring seed capital and substantial investments to new strategies.

Two State Street Investment Management products illustrate the different forms these arrangements can take; how the role of the ETF is evolving in institutional portfolios; and how ETF products are changing.

New Products

The University of California Board of Regents announced last month the launch of the 90/10 Endowment Strategy Index (ticker UCBG) from State Street, seeding the ETF with a $2.5 billion investment, which made it the largest U.S.-listed ETF on record, according to reports. UC Investments provides the 90/10 Endowment Strategy Index under license to State Street.

“We are seeing some asset owners engage more deeply where they have a specific portfolio need, investment framework or implementation challenge that can benefit from the ETF structure,” says Anna Paglia, State Street Investment Management’s chief business officer.

That involvement reflects an evolution in how institutions view ETFs, she says: Rather than treating them only as efficient instruments for obtaining market exposure, allocators are increasingly considering how ETFs can accomplish more specific portfolio objectives.

“What is also evolving is how institutions use ETFs,” Paglia says. “Many may begin with familiar, highly liquid beta exposures and, as they gain experience with the structure, expand into more targeted, active and differentiated strategies. ETFs can offer liquidity, precision and operational efficiency across a range of portfolio applications.”

Using ETFs Differently

The Texas Permanent School Fund, with roughly $65 billion in assets, is one such institution finding greater use for ETFs. In May, the fund purchased approximately 29 million shares—worth about $740 million—in State Street’s actively managed IG Public and Private Credit ETF (PRIV), which invests in investment-grade debt, including private credit, via an agreement with Apollo Global Securities. The fund targets 80% investment-grade, but may invest up to 20% in high-yield bonds and 35% in illiquid securities. As of October 9, the ETF reported 21.93% of its holdings were sourced by Apollo.

“[We are] willing to be an early/seed investor in products when the stability of our capital and long-term approach allows us to gain advantage through a combination of secured capacity, attractive pricing and enhanced access to the investment manager,” Texas Permanent School Fund Co-CIO Stuart Bohart says.

For asset managers, such investments have arisen from long-term relationships with specific allocators. UC and State Street, for example, have maintained a relationship for more than two decades.

A Shifting Role in the Institutional Portfolio

Bohart says ETFs are attractive for managing beta—they are easy to enter and exit, and they allow custom tailoring of a portfolio for risk and asset allocation purposes.

“In the case of PRIV, we believe the ETF also includes an attractive structural edge, which we expect will lead to benchmark-beating performance over time,” Bohart says. “PRIV is part of our broader liquid fixed-income allocation. The ETF structure and supporting market-making give us confidence that liquidity is available; the experience of the investment team and quality of the infrastructure give us confidence in superior risk-adjusted returns; the ETF’s role as core beta in our portfolio combined with our long-term horizon give us confidence that the advantages of our State Street relationship will bear fruit for many years.”

For the University of California, the goal of the partnership with State Street was to make an institutional portfolio widely available. The ETF is based on the office’s $7.9 billion Blue and Gold Endowment Pool, a low-cost, liquid public markets investment vehicle that UC added seven years ago. A statement from UC noted that it has been the best-performing product within its $236 billion portfolio.

UCBG is 90% allocated to the S&P 500 Index, while another 10% is allocated to the S&P U.S. Investment Grade Corporate Bond 1-3 Year Index.

“At UC Investments, we focus on building long-term, cost-effective portfolios to support our hundreds of thousands of UC students, faculty, staff, and alumni for generations to come,” said UC CIO Jagdeep Singh Bachher in a statement. “This record-breaking ETF launch makes our institutional investment philosophy available to a broader community of investors through the transparency, efficiency and accessibility of the ETF structure, while staying true to the principles that have guided our investment approach.”