European institutions increased their allocations to ETFs by 50 per cent in 2018, according to the latest Greenwich Associates European ETF Study.
ETFs now represent 15 per cent of total assets managed by the 127 institutional investors who took part in the Greenwich Associates 2018 study, up from 7.6 per cent in 2016.
“Our data suggests that last year’s robust growth in ETF investments by European institutions occurred not in spite of the turbulent conditions, but because of them,” says Greenwich Associates Managing Director Andrew McCollum (pictured), author of the report, entitled ‘In Turbulent Times, European Institutions Turn to ETFs’.
The USD315.8 billion of global inflows into ETFs in 2018 represented
the second-biggest year ever, behind only the USD467.1 billion recorded in 2017.
Greenwich Associates writes that last year’s robust inflows occurred despite volatile market conditions and the deep sell-off in global equity markets.
The study reveals that growth was driven in large part by three key trends: volatility, index revolution and ESG.
The survey showed that 74 per cent of institutional investors are worried that we are facing the end of a cycle and a possible recession, with 71 per cent – including, the report says, almost all of the buy-side economists – anxious about geopolitical events.
European institutions were repositioning their portfolios to withstand possible central bank tightening and trade wars. The implementation of these changes increased demand for ETFs, the report says with institutions articulating that the speed of execution in ETFs, single-trade diversification and liquidity make them versatile tools for portfolio construction.
The study quotes a correspondent from a large Dutch insurance company saying: “ETFs are cost-efficient and operationally easy to increase or decrease exposure.”
Nearly two-thirds of the investors rank ‘managing risk/return that is in line with objectives/outcome’ ahead of other requirements, such as finding attractive investment opportunities with good returns and at appropriate costs, the report says.
Of the four major types of study respondents – institutional funds, investment managers, insurance companies, and discretionary wealth managers – only wealth managers ranked sourcing attractive investment opportunities on par with risk management as a priority for 2019, the report says.
In terms of the development of indices, Greenwich Associates reports it as ‘an indexing revolution’. The shift of assets from active management to index strategies has been one of the main drivers of growth for ETFs in the institutional channel, the report says, and that trend seems poised to continue in coming years.
About 25 per cent of the assets of investors participating in this year’s study are allocated to index strategies. However, the study notes that current index allocations still fall well below optimal levels, which investors set at 37 per cent of assets in equity portfolios and 34 per cent in fixed income. The gap is a result of legacy portfolio positions, the report says, and seems to shrink each year.
The report finds that European institutions in search of low-cost beta continued shifting assets from active management to index strategies last year. This shift increased asset flows into ETFs, the preferred vehicle for index exposures for 84 per cent of study participants.
Increases in index ETF allocations will come at the expense of active index mutual funds and other investment vehicles, the study found. “ETFs are more liquid than other options,” says a study respondent from a midsize Nordic discretionary wealth management firm. “They offer more niche products, while mutual funds only have a basic level of core allocations. ETFs are cheap and efficient.”
Forty per cent of ETF investors in the study say they have already replaced other investment vehicles in their portfolios with ETFs – up from 34 per cent in 2017. Seventy-two per cent of these investors have used ETFs to replace active mutual funds and that figure climbed 10 percentage points from 2017 to 2018.
The report says that that large jump could reflect investors’ disappointment in the performance of active strategies during a time of heightened market volatility – a period in which active management was expected to demonstrate its value. Growing numbers of European institutions are also using ETFs to replace individual stocks (31 per cent in 2018 vs 24 per cent in 2017) and individual bonds (33 per cent vs. 14 per cent).
Another interesting figure revealed in the report is that every buy-side trader participating in the study said his or her organisation uses ETFs to make tactical portfolio adjustments, with two-thirds saying they use ETFs for cash equitisation, and 50 per cent use the funds for transition management and/or interim beta.
Meanwhile, the study found that smart beta strategies remain a steady driver of ETF growth and demand. Two-thirds of study participants overall and nearly three-quarters of discretionary wealth managers invested in factor-based or smart beta ETFs.
More than a third expected to increase allocations in the next 12 months and almost half of respondents planning to increase smart beta ETF allocations expect to boost these levels by 10 per cent or more.
ETFs are emerging as a primary vehicle for ESG Investing, the report says, with the share of European institutions investing in ESG ETFs continuing to grow in 2018 and appearing to be ‘a sustained source of demand for ETFs’.
The report notes that European investors are at the global frontline when it comes to incorporating ESG into investment decisions, with 44 per cent of participants in this year’s European study, reflecting more than half the discretionary wealth managers, having sold out of or invested in certain strategies due to ESG implications. By way of comparison, only 24 per cent of US investors have bought into or sold an investment strategy on this basis, the report notes.
Some 44 per cent of study participants overall and half the investment managers are using ETFs as a main vehicle to address ESG, the report found, and looking forward, almost half the investors in the study expect to have more than 50 per cent of their total assets managed with ESG criteria within the next five years.
The report found that 55 per cent of all study participants and 75 per cent of the wealth managers agree that “investors are more important than ever to address issues such as climate change and diversity because governments are not doing enough.”
However, these actions are not motivated only by a sense of social responsibility, with 36 per cent of all respondents and 44 per cent of the institutional funds agreeing that “ESG overlays/investments will enhance the likelihood of strong investment returns over the long term.”
Within Europe, iShares/BlackRock is the ETF provider of choice for European institution, by a wide margin. Some 94 per cent of the institutions participating in the 2018 European ETF Study use iShares/BlackRock for ETFs.
Study participants name iShares/BlackRock as the market’s best-in-class provider in all nine of the product and service categories assessed by Greenwich Associates in this year’s study, including liquidity, range of products, value for management fee, index tracking, use of institutional quality benchmarks, servicing platform, innovation, product transparency, and commitment to local markets (presence in the European market).
DB Xtrackers came in second place with 56 per cent of the market, followed by Lyxor, at 47 per cent.
Looking forward, a possible new line of business for ETFs, spotted by Greenwich Associates, is cash, with institutional investors moving to cash as they take on a more defensive stance in portfolio construction. While most institutions will use physical cash or money market funds, some 31 per cent of study participants overall and nearly half the discretionary wealth managers also use ultra-short duration ETFs for cash exposures.
With nearly 40 per cent of existing institutional ETF investors planning to further expand allocations in the year ahead, expect to see continued ETF growth in European institutional portfolios in 2019, the report says.