Institutional Investors Warm to ETFs

Nov 12th, 2012

Institutional investors warm to ETFs - David Kaufman

Although retail investors in recent years have quickenedtheir adoption of exchange-traded funds to build balanced portfolios,especially with the increasing correlations among individual securities inrecent years, institutional investors continued to favour index funds andderivatives - that is, until now.

One reason for the change of heart is cost. Themanagement fees of many ETFs have essentially become mere rounding errorsbecause of healthy competition among ETF providers and streamlinedmanufacturing capabilities. Where an annual management fee of, say, 0.3% for aninstitutional-grade index mutual fund used to be considered competitive,institutions can now buy the same ETFs you and I buy for a management fee of amere 0.05%.

But low cost and the ubiquity of ETFs are not the only drivers behind the newfound institutional love for ETFs. The use of these products as tools in tactical allocation strategies and as risk mitigators is also playing an increasing role.

Since institutions are not immune to the ever-increasing correlations among individual securities, many have turned to tactical allocation models for the core part of their portfolios - models that allow forreal-time allocation and reallocation among various global asset classes andrisk factors.

These strategies require tools that are liquid, transparent, inexpensive, targeted and without capacity constraints. ETFs haveall of these elements, and, therefore, are becoming the tool-of-choice amongpensions, endowments and foundations to access these various markets.

Similarly, in the area of dynamic risk management, institutions historically used complex derivatives to hedge various risks, whether related to interest rates, markets, currencies or geographies. Now, many of these hedges are available through the simple trading of ETFs, providing a much-needed function to any investor unwilling to place investments withmultiple risk factors.

In an effort to highlight the growing use and usefulnessof ETFs in achieving institutional investment objectives in an uncertaineconomic environment, the Toronto Stock Exchange and the Canadian ETFAssociation (CETFA) are hosting the first joint TSX/CETFA Exchange Traded FundConference for Institutional Investors on Nov. 27, 2012 at the TSX.

The conference will have panels covering a variety of ETF-related topics important to institutional investors such as indexing, risk management, tactical allocation strategies and even a "myth busting" panel aimed at addressing some of the many misconceptions regarding ETFs held by retail and institutional investors alike. I will be moderating a panel on "emerging strategies for institutional investors using ETFs" at the conference.

The majority of Canadians are affected by the efficiency with which institutional investors are able to execute their strategies and manage risk. Anyone collecting a pension or benefiting from the work of an endowment or foundation should be happy to know that developments in the ETF space are facilitating the optimization of this process. And this is just the beginning.