Institutions Still Wary Of ETFs

July 26, 2019

[This article appears in our August 2019 issue of ETF Report.]

For the second year in a row, Keefe, Bruyette & Woods (KBW) has surveyed institutional investors to see how and why they use ETFs, especially equity ETFs. The results are interesting, and we provide some key highlights.

KBW solicited data from 26 institutional investors, 64% of which were hedge funds or private equity firms. The mix also included responses from mutual fund/insurance and institutional wealth managers, banks and endowments/foundations. Overall, 60% of participants had less than $1 billion in assets under management, while 20% had more than $5 billion.

“If you think about the nature of the institutional business, they’re being paid for their stock picking,” said Melissa Roberts, a managing director and research analyst at KBW. ”Using an ETF is somewhat contrarian to their business.”

“The way in which they’re using ETFs is kind of creative,” she added. “But also because it’s creative and unique, it’s taken them longer to ramp up an acceptance of them.”

Blessing Or Curse?
More than half the respondents said they thought of ETFs as a game changer, a “useful tool/investment option,” but 31% chose a far darker option, labeling ETFs a “ticking time bomb” that’s a “temporary market disruption, with limited long-term use.” (See Figure 1.)

 

 

As an insight as to why they might think that, 100% of respondents said ETFs have an impact on the prices and volumes of their underlying stocks, with concentration risk seen as the biggest risk associated with the vehicles. Other top risks mentioned by the 19 respondents who answered the question included liquidity and tracking error (see Figure 2).

 

 

The concerns with concentration risk were based on the idea that ETFs were crowding into the same names, concentrating exposure in relatively illiquid securities and changing the fund-flow dynamic in individual stocktrading, Roberts said. She noted also that as stock pickers, institutional investors are likely more interested in the impact of ETFs on individual securities.

With quite a few participants seeing ETFs as ticking time bombs, it’s not surprising that roughly 46% said they weren’t invested in ETFs. However, of those that do  invest in them, 54% said they use them as trading tools or for risk management, while 46% said they use them for asset allocation purposes.

Of those institutions invested in ETFs, 38% have less than 10% of their assets allocated to ETFs, while 12% have 10-25% in ETFs, and just 4% have between a quarter and half of their assets in ETFs.

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