The use of ETFs in Australia has grown almost 50 per cent since the beginning of 2013 reaching just shy of $10bn in funds under management as at the end of December. While in the early years growth was driven by retail investors, recent activity suggests ETF uptake by institutional investors is on the rise.
Overseas in 2012 over 90 per cent of the largest US mutual funds used ETFs as well as over 80 per cent of the largest 20 US hedge funds (Source: Bloomberg), while in Europe, according to a 2012 EDHEC Survey, 70 per cent of institutions surveyed used ETFs.
While the Australian market is less developed than the US or Europe, 2013 has seen greater institutional activity in the Australian market. Such usage has come from multi-managers, superannuation funds and fund managers. Some of the more popular institutional strategies are as follows:
Cash equitisation
Investors use ETFs for cash equitisation to allow them to remain more fully invested in the period between choosing positions, while still maintaining liquidity and eliminating potential cash drag on portfolio performance. Cash equitisation is often enabled through futures but ETFs have the benefit of being transparent, requiring less documentation and being free from potential roll slippage.
Another advantage of using ETFs over futures is that ETF exposure normally provides dividends and franking credits (for Australian equities exposures) which can reduce tracking error. The value of dividends and franking credits earned may potentially offset some of the costs involved in owning ETFs.
Liquidity management
This strategy involves using ETFs for a given percentage of each asset class exposure to provide a liquidity buffer across allocations. Institutions can increase liquidity without changing the composition of the overall asset allocation through ETFs compared with allocating money to investment managers. For assets classes such as commodities and other alternatives, ETFs may provide significant liquidity enhancement relative to managed funds.
Transition management
Transition management through ETFs allows funds to maintain market exposure while moving to a new manager. Investing the proceeds of manager liquidation provides access to relevant asset classes and reduces the amount of uninvested funds in a portfolio.
Rebalancing
Institutional funds can use ETFs to implement shorter term adjustments by rebalancing across different asset classes with speed and efficiency, especially when compared with moving assets from illiquid managers.
Asset class exposure
ETFs provide exposures to otherwise difficult to access asset classes such as commodities and emerging-markets, or even access to short exposures. They provide low-cost, liquid exposures and can fill any asset allocation holes without engaging a new investment manager.
Dynamic asset allocation
This involves using ETFs to over or underweight certain market segments based on a short-term outlook. ETFs available on ASX now represent a wide variety of the key asset classes and they are increasingly considered as efficient vehicles for implementing a short to medium term outlook.
Alex Vynokur is managing director of BetaShares