ETFs REPLACE DERIVATIVE POSITION IN PORTFOLIOS
Another reason behind the growth in European institutional interest is to replace derivatives positions in institutional portfolios.
In the Greenwich Associates survey, 41% of respondents said they planned to replace equity futures with ETFs, while 11% had replaced existing commodity futures positions with ETFs.
Garcia-Zarate explains ETFs are “very flexible tools”, which explains why one of their uses is providing alternative solutions to the use of derivatives.
“For example, there are very few futures contracts with deep liquidity,” he says. “By contrast, there are plenty of very liquid ETFs providing multiple exposures that can be rolled out in a portfolio.”
This is not to say ETFs are always better than futures for all situations. GarciaZarate adds: “It simply means that portfolio managers now have the ability to use a large number of ETFs in this manner. So, they certainly have more choice.”
Mellor agrees institutional investors are increasingly using ETFs to replace derivatives in portfolios.
He says: “The obvious example is in the use of futures. Changes in the dynamics of the futures market ,coupled with increasing competitiveness in ETF pricing, means that for many benchmarks it is more cost effective to invest via ETFs than futures.”
Another reason more investors may turn to ETFs is they are often cheaper than futures and easier than single shares. The growing popularity of multi-asset funds is also creating new demand for ETFs among the asset managers that offer these products. One corporate pension fund who wishes to remain anonymous says: “We use ETFs when we have to act quickly, when a highly-liquid investment is requested.”
There is no doubt the future growth of ETFs in the UK market will be driven by the new and sophisticated applications for institutional investors. Europe might currently sit behind the US when it comes to institutional investors embracing ETFs, but in an uncertain and ever-volatile investment environment, that gap could soon close.
