In the US, about 45 per cent of pension funds and 55 per cent of funds managers are using ETFs to tactically adjust their portfolios.

Cash equitisation

This strategy involves using ETFs to remain fully invested while maintaining liquidity to eliminate the cash drag on portfolio performance. For this purpose, ETFs represent an attractive alternative to investing in futures as they are more transparent, less documentation is required and there is less chance of rollover slippage.

In the US, 63 per cent of funds managers and 31 per cent of pension funds are using ETFs for cash equitisation.

Core/satellite

The statistics from a recent European ETF survey sponsored by EDHEC in 2010 show when implementing core/satellite strategies using ETFs, sector investments and commodities exposure are some of the most common elements of the satellite strategy.

Institutions are particularly drawn to the simplicity of ETFs for exposures such as gold as a means to gain pure exposure compared to the complexity of obtaining similar exposure via the derivatives markets.

For institutional investors, understanding how commodities ETFs track the price of the asset class is critical before making an investment. Knowing whether the ETF is physically backed and has a currency hedge will determine whether it will provide the desired outcome.

Rebalancing

Through dynamic active management, institutions can use ETFs to implement shorter term adjustments by rebalancing across different asset classes in a speedy and efficient manner. This is particularly true when moving assets from illiquid managers. About 24 per cent of US pension funds and 31 per cent of US funds managers who are using ETFs have embraced this strategy.

Pairs trading

Many hedge funds in the US are actively invested in ETFs to hedge exposures through pairs trading. How such a strategy is implemented is, a fund might pick alpha stocks in the financial sector and then short the financial sector ETF or vice versa. By using this strategy, the fund has removed systematic and industry risk from the stock, leaving a pure alpha exposure based entirely on stock picking.

Insto use of local ETFs

There is no doubt that one of the biggest barriers of ETF adoption in Australia is the relative fees compared with hiring an index manager. While fees will always be important, ETFs should be considered and can co-exist with index managers particularly when an investor is seeking to actively tilt and rebalance portfolios to provide the best outcomes.

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