It would be fair to say the marriage between UK pension schemes and exchange traded funds (ETFs) has had a shaky start. It seems to me, rather than having entered the honeymoon period and then into happily-wedded bliss, their relationship never really started and so UK pension funds and ETFs have barely even consummated things, let alone moved beyond that.
This is because despite global assets in ETFs passing the $2trn (£1.32trn) mark in January, UK pension funds have yet to show considerable interest in the products, unlike the retail investment sphere or investors in the US where the asset class has boomed in recent years.
Earlier this week, I hosted one of our roundtables on ETFs and their role in institutional portfolios (the full discussion will be published with June’s portfolio institutional). One of the thoughts the panel ended on was: if we were to repeat the roundtable a year down the line, little would have changed in terms of pension funds’ use of ETFs.
I realise 12 months is not a long time in institutional investment, but the fact that nothing is expected to change in that time suggests something in the relationship is clearly amiss.
ETFs are of course used tactically by institutional investors for their easily tradable and liquid qualities, as well as their lower fees compared to pure active management. Often they are utilised in transition management for the time out of market or, as one roundtable participant termed it, for “dipping a toe” into new asset classes.
The fact remains however, their usage among UK institutional investors is minimal. At first, I thought this might be because a typical passive global equities index fund can be picked up for, say, 10-15 basis points (bps), compared to an equivalent ETF for 25-50bps. But while this is probably true in some cases, an equally important factor which is stifling a full and lasting love affair between investors and ETFs is the lack of education.
When it comes to ETFs, investors should judge each on its merits and with the help of their advisers look at them on a product-by-product basis. But in order to do this they need more education about what exactly they do for the portfolio and, as with other investment strategies, should look beyond just the costs.
ETFs could gain traction in institutional if the trend for provider consolidation continues and drives performance competition and subsequent lower pricing. This, combined with a better understanding of what ETFs do, might just save this rocky marriage yet.
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