Institutions are increasingly using exchange-traded funds (ETFs) as precision investment tools to access new investment opportunities with simple and efficient trades that would not have been previously considered or possible.
To demonstrate the new ways ETFs are being used by institutional investors, the iShares Institutional team at BlackRock offers three case studies: Glovista Investments getting exposure to “illiquid” Frontier Markets, Laffer Investments accessing unexpected liquidity from a new ETF, and an insurance company improving operational efficiency in smaller portfolios.
Daniel Gamba, head of Americas iShares institutional business at BlackRock, says: “Institutional investors today are looking for investment solutions that use iShares ETFs in innovative and new ways to get targeted, bespoke investments with efficiency and simplicity. To ensure a positive ETF investing experience, we take a holistic, soup-to-nuts approach to helping our clients determine the best portfolio solutions and trade execution strategies. This consultative approach yields new solutions that neither the client nor we would have considered individually. And, as a result, the list of ETF uses among different institutions keeps growing.”
Case study one: ETFs providing access to “illiquid frontier” markets
Glovista Investments LLC, an investment advisory firm and global macro manager with USD900 million in AUM primarily for institutions, is well-known for its flagship Emerging Markets Equity Strategy. Their strategy uses ETFs to access single emerging markets countries and has the ability to allocate up to 10 per cent of the portfolio to non-benchmark opportunistic positions. Earlier in the year, Glovista was interested in making a tactical bet in frontier markets because of their attractive valuation and positive earnings outlook at the time, and their belief that its emerging markets strategy would benefit from short-term exposure to the higher beta of frontier markets.
Frontier markets can be very illiquid and difficult to access efficiently especially when a manager wants to take a short-term position. The costs of trading in and out can become very costly with investments in underlying securities. Glovista looked for a solution that would allow opportunistic exposure to Frontier Markets in a liquid instrument and at a reasonable spread level.
Glovista selected the iShares MSCI Frontier 100 ETF (FM) that provides exposure to 100 of the largest and most liquid stocks in frontier markets. Launched in September 2012, FM has over USD800 million in AUM and is the only ETF listed in the US that provides pure exposure to companies domiciled in frontier countries such as Kuwait, Nigeria, Pakistan, among others.
Glovista worked through its broker on one large block trade of USD10 million and the position was executed inside the offer with minimal impact. The liquidity of the ETF, in combination with willingness of market makers to make risk markets, made a trade of this size possible in one large block trade so Glovista could efficiently act on its convictions.
Darshan Bhatt, co-founder and co-portfolio manager of Glovista Investments, says: “When institutions typically think of emerging markets or frontier markets, they wonder if, how and at what cost they can efficiently access these markets. We inform our clients that ETFs provide us an efficient vehicle to access exposure to specific emerging and frontier markets. The transaction costs and bid-ask spreads of ETFs are much more cost-effective than trading the underlying securities or ADRs.”
Case Study two: Accessing unexpected liquidity from a new ETF
Laffer Investments, an asset manager with USD732 million assets under management (AUM) that manages global asset allocation strategies, as well as provides macroeconomic investment research with its affiliated Laffer Associates, wanted to gain exposure to specific parts of Europe and had particular interest in accessing Germany and hedging its currency at the same time.
The challenge was that among the various precision instruments to orchestrate a Germany hedged position, Laffer considered the iShares Currency Hedged MSCI Germany ETF (HEWG), but the size of the new ETF launched in February 2014 was small at approximately USD2.5 million. Laffer was contemplating an allocation of USD40 million, which would represent 1020 per cent of the fund’s average daily dollar volume and 1580 per cent of the fund’s total AUM.
It is common for institutional investors to be interested in investing in a new ETF, but the ETF typically needs time to grow before it has enough size and secondary liquidity. While developing HEWG, iShares recognised the immediate interest large investors would have in the product, so it designed HEWG to invest in the unhedged iShares MSCI Germany ETF (EWG) and implement foreign currency forward contracts as the hedge.
iShares provided Laffer with pre-trade analysis to show that a trade in HEWG could benefit from EWG’s liquidity and average daily dollar volume of over USD100 million. Laffer decided to place one large block trade with a limit order through their broker and the position was executed at the offer with minimal impact. The bid/ask spread of HEWG was three cents wide (12bps) and the bid/ask spread of EWG was one cent wide (3bps) at the time of execution.
The liquidity of the underlying basket made a sizeable, one block trade possible, enabling Laffer Investments to quickly act and invest on its views about Germany.
Case study three: ETFs improving operational efficiency in smaller portfolios
A mid-sized insurance company with USD5 billion in assets had several subsidiary portfolios with assets USD30 to USD60 million. The company was looking for a way to transition these portfolios out of cash with the goal of meeting the investment and yield objectives of each entity, but wanted to do so in an operationally viable and cost efficient way.
The challenge the client was facing is quite common. Many insurers are required to maintain small sub-portfolios matched to specific lines of business or liabilities. Typically they are holding a small undiversified portfolio of single bonds or cash that often do not match the company’s investment policy.
Many insurance companies are starting to use ETFs to provide operational efficiency, portfolio diversification and a better investment result, allowing investment staff to increase focus on the larger general account.
BlackRock’s iShares team worked with the client to identify which ETFs would match the client’s asset allocation needs and objectives of each subsidiary entity. The client invested in the iShares MBS ETF, iShares iBoxx USD High Yield Corporate Bond ETF, iShares iBoxx USD Investment Grade Corporate Bond ETF and iShares National AMT-Free Muni Bond ETF, executing trades of USD3 million to USD25 million in size over several days with minimal market impact. This ETF solution significantly reduced transaction costs versus trading the cash bonds and it also provided on-exchange trading simplicity and liquidity.