Institutional investors across Canada are broadening the ways they use exchange traded funds and embracing more strategic applications for ETFs in their investment portfolios, according to a Greenwich Associates study.

In its second year of fielding of Canadian-based institutional users of ETFs, sponsored by BlackRock Asset Management Limited (BlackRock Canada), the Greenwich Associates results found that 40 per cent of institutional funds and asset managers surveyed expect to increase their use of ETFs in the coming year – up from just above a third last year.

Overall, the Greenwich Associates study found that institutional usage of exchange-traded funds is growing, in part due to the increasing use of ETFs in fixed income and other asset classes beyond equities. Of those already regularly using ETFs in their existing portfolios, 40 per cent of Canadian institutions intend to increase allocations and move more assets to ETFs by 2015. Moreover, half of the institutions participating – and particularly asset managers, who actively manage money for institutional funds – say that their use of ETFs overall is strategic rather than tactical.

"This is really a continuation of a trend we’ve been seeing develop for several years now," said Greg Walker, Managing Director, Head of iShares Institutional Business, BlackRock Canada. "Not only are institutional investors like pension funds, foundations and endowments realizing the benefits of ETFs, but increasingly asset managers are as well. It’s more than a numbers game – institutions are using ETFs more, but also in more ways. And the growth in fixed-income ETFs is really remarkable."

As in last year’s study, half of institutions say that their use of ETFs is strategic in nature, in part attributable to the wider and more diverse ETF product set. This is further evidenced by the growing use of fixed-income ETFs by institutions, who are realizing the benefits of the funds in terms of liquidity and cost transparency in an often-difficult-to-access bond marketplace.

Fixed Income Drives ETF Growth:

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While institutional investors most widely use ETFs in equity portfolios; in the study, 80% use the funds for domestic equity and 85% use them for U.S. equity exposure, this year’s study revealed an increasing use of the funds for fixed income allocations. In fact, half of the institutions participating employ ETFs in fixed income, and more than 20% of those using bond ETFs began doing so less than two years ago. Among asset managers, 57% are now using ETFs in fixed income – up from only 45% just one year ago.

The most frequently cited benefits for institutions: ease of use and ease of access, as well as the high liquidity ETFs offer. In a low-yield environment, institutional investors are seeking new sources of yield and looking for better and more efficient ways to access the asset class in a shifting interest-rate environment. Coupled with their heavy usage of passive index strategies, institutions are increasingly turning to ETFs to achieve those efficiencies. In fact, more than a quarter of institutions now using ETFs in fixed income plan to increase allocations to bond ETFs in the coming year.

Remarkably, more institutions are using ETFs to gain exposure to similarly illiquid or hard-to-access asset classes. According to the study, 38% deploy ETFs in commodities and 27% use the funds in REITs.

From Tactical Tools to Strategic Elements:

ETFs have long been used by institutional investors as tactical tools in manager transitions, portfolio rebalancing or cash equitization. Those remain important uses, as about two-thirds of institutional ETF users say they deploy ETFs to make "tactical adjustments" to portfolios. However, half of the institutions in the study say their use of ETFs is mainly strategic. Two-thirds of this group use ETFs to obtain passive exposures in the "core" components of core/satellite strategies, while other common strategic applications include portfolio completion, hedging and liquidity sleeves.

"As institutions become more familiar with the benefits and the range of ETFs available, they are also figuring out better ways to put the funds to use beyond tactical adjustments," said Walker. "One proof point for the increasing strategic deployment of ETFs is that more institutions are beginning to hold them for longer periods of time."

According to the study, asset managers holding ETFs longer than two years grew to 31% up from 24%.

Liquidity matters:

While the uses of ETFs vary, institutional investors seem to agree on the most important criteria for ETF selection: liquidity and trading volume. More than three-quarters cited liquidity/trading volume as an important factor in selecting a fund, while 83% said they are concerned about the liquidity of funds in which they invest. The second most important criteria overall was cost, but asset managers are far more concerned with expenses than institutional funds are: 60% of asset managers cite cost as an important consideration, compared with just 17% of institutional funds.