Institutional Uses Of ETFs

August 25, 2008

Institutional Use Of ETFsThe exchange-traded fund was born as an institutional product 15 years ago, when State Street Global Advisors (SSgA) and the American Stock Exchange together launched the first ETF, the SPDR S&P 500 ETF (AMEX: SPY). Originally known as the Standard & Poor's Depositary Receipt Trust, it was almost exclusively traded by institutions.

Over the past few years, however, the big story in ETFs has been the growth in individual and intermediary-driven assets. Fund companies have been pushing aggressively to grow this market, positioning ETFs as "institutional-quality products for a retail audience." The media has been covering this growth closely.

Amidst the retail upswell, however, there's been a second, quieter and equally important growth story developing: continued growth in the institutional market for ETFs.

This story gets less coverage, but in some ways institutional usage is even more compelling. At the end of 2006, 2,214 institutions held ETFs (according to Morgan Stanley research based on SEC Form 13F filings) representing 15 percent growth on a year-over-year basis and double the amount in 2001. Usage has spread from original adopters such as pension funds to a wider range of institutions, including mutual funds, hedge funds, endowments and other large investors.

According to State Street:

  • 17 of the 20 largest mutual fund complexes use ETFs
  • 15 of the 20 largest hedge funds rely on ETFs (especially the very liquid SPDR S&P 500 ETF)
  • Each of the five largest endowments among U.S. universities has ETFs among its top 10 holdings

An important question is, why? Individual investors gravitate toward ETFs and mutual funds in general because they let a professional portfolio manager take over the risk and technical challenge of buying exposure to the market. But institutions typically hire their own portfolio managers to pick securities and create portfolios. Why do they still account for a significant portion of the ETF market? What specific value do ETFs provide to the institutional market?

This paper looks to examine the data on ETF usage among institutional investors and explore how and why these investors are utilizing ETFs in their portfolios.


Mutual Funds

ETFs have become a hugely popular tool for mutual fund families looking to equitize cash, gain strategic exposure to sectors or countries, or build fund-of-funds portfolios at low costs.

The list of mutual fund families that utilize ETFs includes many of the world's biggest asset managers, from Vanguard and Fidelity to Janus, Oppenheimer, BlackRock Advisors and more.


Top Mutual Fund Families

As of year-end 2007, according to 13F filings, of the 20 largest mutual fund companies, Columbia Management Advisors (a unit of Bank of America) held the most assets in ETFs, at $7.93 billion spread among 147 individual funds. That number was down 27 percent from September 30, and represented 2 percent of Columbia's total $409 billion in assets under management.1

Columbia's ETF positions were spread throughout the industry. It held 86 ETFs from Barclays Global Investors' iShares unit and 21 managed by State Street Global Advisors. Vanguard and PowerShares made up the next largest contingents, with Merrill Lynch's HOLDRS portfolios coming in fifth.

Figure 1

In comparison, Fidelity Management & Research ended 2007 holding the most individual ETFs (171), a 28 percent increase from the end of the third quarter. But according to State Street Global Advisors, the total assets in those funds were just $593.2 million. iShares comprised the majority of Fidelity's holdings with 94 funds, while State Street came in second with 29 ETFs. The fund giant also held ETFs from Vanguard, Market Vectors, Rydex (CurrencyShares) and PowerShares.


Most Popular ETFs

Not surprisingly, the list of the most popular individual ETFs among mutual funds includes many of the largest and most liquid funds on the market.

As of December 31, 2007, the last date for which complete data is available, the iShares Russell 2000 ETF (NYSEArca: IWM) was the most popular ETF amongst mutual funds by assets, with funds holding $1.8 billion in IWM shares. The iShares S&P 500 ETF came in second with $1.4 billion in assets, followed by the SPDR S&P 500 ETF (AMEX: SPY) with $1.3 billion in assets.

Figure2

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