ANALYSIS

SWFs surprise as they debut in ETFs

The institutional usage of exchange-traded funds is booming around the world, putting paid to any lingering doubt that the vehicles are meant for retail investors. Michael Bailey reports.

Deborah Fuhr

Deborah Fuhr, the global head of ETF research for the world’s largest ETF provider, BlackRock, says there is evidence that more institutional investors now preferred ETFs over futures for such purposes as cash equitisation, transition management, rebalancing and the achievement of hard-to-obtain exposures, particularly in emerging markets.

“It’s true that you need the full cash amount to fund an ETF purchase, whereas a futures contract might only require a 10 per cent down payment on the face value, but there is an admin margin there and you don’t get any of the benefit of dividends,” Fuhr says.

She cites a recent Greenwich Associates survey of ETF use among US institutional investors, which found 14 per cent of the 70 respondents (including 43 pension funds) had used ETFs, most commonly for tactical tasks related to portfolio management.

However, one-fifth of those institutional ETF users reported using the vehicles to implement strategic or long-term investment decisions.

Even though a large segregated mandate with an index manager tends to be much cheaper than an ETF, the exchange-traded option saves investors the hassle of setting up a custodian account in a new investee country, says Susan Darroch, an SSgA structured products executive in the Asia-Pacific.

The institutional popularity of ETFs is not limited to the US. Recent disclosures by the $300 billion Chinese sovereign wealth fund, the China Investment Corporation (CIC), revealed that it held about $9.6 billion in US-listed securities, $2.4 billion or about 25 per cent of which was invested in ETFs.

The CIC also revealed extensive ETF holdings in gold, commodities and energy-related indexes.

On the flipside, Blackrock’s Fuhr says a growing source of demand for ETFs came from investors wanting to access mainland China shares, but being unable to do so because they either did not have a Qualified Foreign Institutional Investor licence, or had exceeded the quota assigned them under their licence.

“Institutions are realising that by using a [Hong Kong-listed] “H Share” ETF, they don’t need to worry about the quote,” Fuhr says.

Globally, Fuhr says MSCI remained the most popular index provider on which to base an ETF, because its “consistent methodology” supported the ETF base-case of transparency and tight tracking of their underlying indices.

She says the ETF market is unlikely to see a proliferation of players, because brokers “only become excited about being market makers in these things when they know the volumes are going to be big”.

The global ETF industry will face a big challenge if the European Parliament passes the Alternative Funds Directive, because it will force all European institutional investors to invest in pooled funds with UCITS licensing only.

However, Fuhr points out that European funds are major investors in US-domiciled ETFs, which spurn UCITS in favour of “1940 Act licencing.

“You could see European pension funds forced to liquidate their US ETF holdings,” Fuhr says, predicting that US-based ETF providers will have to establish UCITS-compliant versions of their products.

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