Top 5 New Institutional ETF Trends

April 24, 2018

ETFs Aren't Replacing Just Mutual Funds

Lots of ink has been spilled over how ETFs have vacuumed up flows from active mutual funds, but actually they're not the only instruments being displaced by ETFs. Investors are also increasingly substituting in ETFs for individual stocks, bonds and even futures positions.

Nearly half of study participants who reported using futures for their beta exposure say they'd subbed out derivatives for ETFs over the past year. Sixty (60%) reported they were at least thinking about doing so in the future.

"This is probably the single biggest conversation we're having with clients right now," said Goutam.

The majority (58%) of institutions who said they planned to sub in ETFs for futures reported they wanted to do so to lower costs. With higher round-trip costs (including bigger commissions and margin requirements, as well as regulatory pressures inflating costs), futures can be significantly more expensive than ETFs with similar exposure.

"Often, futures contracts aren't just 5-10% more expensive [than ETFs], they end up being 5-10 times more expensive," noted Goutam. "It's a magnitude higher."

Futures also exhibit higher volatility in their roll costs (meaning, the cost to roll from one expiring contract to a new one—essentially, the cost of maintaining constant exposure). For example, over the past five years, the S&P 500 Index futures contract has seen both its most and least expensive roll costs in that contract's history. By using ETFs instead, institutions can mitigate some of that volatility.

ETFs aren't always the cheaper option, added Goutam, but "there are pensions doing the math and moving billions of dollars from futures contracts and into ETFs. They're not just sticking with the way they've done things previously."

There's Alpha, There's Beta & Now Factors

Factor investing isn't quite mainstream yet, but it's getting there. Forty-four (44%) of survey respondents reported using nonmarket-cap-weighted or smart-beta strategies in 2017, up 7% from the year prior.

 

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Much of that demand growth has come from wariness over the possible return of market volatility. Sixty-two (62%) of institutions already investing in smart beta use minimum-volatility ETFs, making them also the most popular smart-beta category.

The trend toward factors belies a shift in the way investors are thinking about alpha and beta, says Goutam. His clients are increasingly evaluating their portfolios in terms of which factors are overweight and which are underweight, and whether one exposure unintentionally boosts or neutralizes the other.

"They want to make sure their net factor exposure is consistent with their investment view," said Goutam.

Interestingly, investors seem to slightly prefer multifactor funds over single-factor funds (53% to 50%). This difference is likely to grow: Of those investors who planned to increase their use of smart-beta products, 48% say they planned to add multifactor ETFs, while 41% planned to use single-factor ETFs.

 

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