Trends in Institutional
Investor Use of Fixed
Income ETFs
Presenter:
ANDREW MCCOLLUM
Partner & Managing Director
Greenwich Associates
Table of Contents
Drivers of Growth
Institutional Fixed-Income ETF Outlook
Conclusions
Role in Institutional Portfolios
Direct feedback from the institutional community.
The Appeal of ETFs in the Institutional Market
“We have found a lot of new
innovative products are
available in ETF form.” – RIA
“At times active managers
have difficulty beating their
benchmarks and ETFs are
considerably less
expensive
.”
– Pension fund
“ETFs allow me to
diversify exposure to
style, market
capitalization and
sectors that I would not
be able to efficiently
achieve trading
individual names. The
key word is
diversification.”
– Asset manager
“We are making greater use
of ETFs as we delve into
other parts of the market
that we would not access
with individual stocks, such
as European, international
and emerging markets. Over
time, we will make even
greater use of ETFs as we
try to tap additional areas
of the market
.” – RIA
“We use ETFs to fill out when we
can’t find individual bonds.”
– Investment manager
“It started out as a
tactical tool to
temporarily hold cash;
over time our use has
evolved into
permanent holdings
.”
Greenwich Associates
5
Fed Policy
Regulatory and policy shifts upended fixed income markets, spelling uncertainty
for its participants.
The Root Cause of Growth
• U.S. Federal Reserve - Low interest
rate environment put in place to
inject liquidity and help spur
economic growth
• Dodd-Frank – Limited size of
financial institutions and lowered
tolerance for risk market-wide
• Basel III – Heightened liquidity
standards for financial institutions
Regulatory Shifts
Dramatic increase of bond issuances
in pursuit of cheap money flooded
primary markets
Confluence of regulatory restrictions
constricted liquidity in
Illiquidity in Fixed Income Markets
Increased regulatory pressure on financial institutions and a flooded bond
market combined for depleted dealer inventories, high costs, and volatility.
Investor Concerns
• When should I buy the bond?
• Will I have trouble offloading the
bond?
• When would I expect to sell? Is
that feasible?
• How do I recalibrate my portfolio
to adjust for this difficulty?
• How do I offset the increased
cost executing trades?
Note: Based on 119 respondents in 2015. Source: Greenwich Associates 2015 U.S. Fixed Income ETF Study
No
48%
Yes
52%
5%
61%
34%
More
Challenging
About the
Same
Less
Challenging
Fixed Income Trading Environment Over
the Past Two Years
Challenges in Trading, Liquidity
or Sourcing Securities
in Fixed Income Markets
Have Challenges Affected
Investment Process?
Drivers of Growth
Investors employ Fixed-Income ETFs for a variety of applications.
Many Tools in the Toolkit
Note: Based on 60 respondents: 10 institutional funds, 21 RIAs, 22 investment managers, and 7 insurance companies in 2015. Source: Greenwich Associates 2015 U.S. Fixed Income ETF Study
43%
43%
0%
57%
57%
14%
71%
57%
32%
45%
27%
41%
73%
64%
59%
64%
38%
33%
19%
43%
73%
62%
76%
76%
10%
10%
20%
30%
40%
60%
70%
80%
ETF
Overlay/Liquidity
Sleeve
Transitions
Hedging
Cash
Equitization/Interim
Beta
Tactical
Adjustments
Portfolio
Completion
Rebalancing
Passive Exposure
in the Core
Insurers
Investment Managers
RIAs
Institutional Funds
Greenwich Associates
Current ETF users are broadening their deployment of fixed-income ETFs from
tactical applications to more strategic portfolios uses.
Broadening from Tactical to Strategic Use
42%
57%
58%
63%
74%
2011
2012
2013
2014
2015
Source: Greenwich Associates U.S. Exchange-Traded Funds Study.
Note: Based on 201 responses: 49 institutional funds, 19 investment consultants, 31 insurance companies, 70 RIAs, and 32 asset managers in 2014. Percentages may not add to 100 due to respondents preferring not to answer.
.
% of Fixed-Income ETF Assets
Considered Strategic
Average Fixed-Income ETF
Holding Period
70%
62%
62%
46%
1 Year or More
2015
2014
2013
2012
9
Healthy trading volumes and asset growth positions ETFs as complements to
traditional fixed income securities.
Serving as a Complement to Bonds
75x
17x
Positive
Velocity
1.7x
2.1x
Negative
Velocity
Trade Volume Growth Since 2008
Total Asset Growth Since 2008
Source: Greenwich Associates 2015 U.S. Fixed Income ETF Study
Fund assets and trading volume compiled from Bloomberg. Trading volumes based on cumulative monthly ADV from the period 12/31/2007– 12/31/2014. “Five largest credit ETFs” determined by ranking the total net asset value of the funds as of 12/31/14.
Overall Investment Grade and
High-Yield Credit Market
Five Largest Credit ETFs
3%
6%
6%
9%
9%
16%
19%
19%
34%
38%
Ability to Use Instead of Individual Bonds
Easy to Use/Access
Good Value/Low Cost
Use of a Placeholder/Replacement
Tactical Asset Allocation
Use for Duration Management/Transition
Diversification
Depends on Business/Client Requirement
More Liquidity
Ease of Exposure
Reasons for Using Bond ETFs Alongside
Individual Bonds
Greenwich Associates
Given liquidity issues, investors have looked elsewhere for fixed income
exposure, primarily derivatives.
More Cost Effective Beta than Derivatives
• ETFs offer another option to
investors using derivatives to gain
fixed income exposure.
• 61% believe S&P 500 ETF provides
more cost effective beta exposure
than S&P 500 future.
• 43% have shifted to ETF from
derivatives in the past year.
• 15% will replace existing fixed
income futures position with ETF in
the next year.
Yes
58%
No
42%
No
72%
Yes
28%
Bond ETFs as Substitutes for Derivatives
Use of Derivatives (Credit Default
Swaps, Treasury Futures, Total Return
Swaps) to Gain Fixed Income Exposure
1Would Consider Using Fixed-
Income ETFs as Alternative to
Gain Fixed Income Exposure
2Note: 1Based on 128 respondents in 2015. 2Based on 36 respondents in 2015 who use derivatives
Source: Greenwich Associates 2015 U.S. Fixed Income ETF Study
Investors not currently using fixed-income ETFs cite several common themes
behind their hesitations.
Barriers to ETF Adoption
• Despite asset growth, perceptions of
limited liquidity still persist.
• Specific events add fuel to concerns
about liquidity when it is needed
most.
• Internal rules and guidelines have yet
to evolve at certain organizations.
• 40% of those who feel uncomfortable
trading ETFs attribute that feeling to
a lack of understanding of the
product.
8%
8%
12%
15%
20%
27%
28%
48%
ETFs Not Supported on Trading/PM
Platform
Regulatory Limits
Lack of Understanding/Familiarity
Expenses
Investment Guidelines
Constant Maturity Profile of Many ETFs
vs. Declining Maturity of Bonds
Internal Limits
Low Trading Volumes or Assets
Reasons Institutions Don’t Currently Use
Fixed-Income ETFs
Note: Based on 60 respondents: 10 institutional funds, 22 investment managers. 21 RIAs, and 7 insurance companies in 2015. Source: Greenwich Associates 2015 U.S. Fixed Income ETF Study
Institutional Fixed-Income ETF Outlook
ETF demand likely to mirror broader shifts in institutional fixed income product
demand.
Shifting Fixed Income Dynamics
4%
19%
1%
9%
9%
5%
9%
7%
9%
14%
14%
15%
20%
22%
23%
24%
Asset-Backed
U.S. Treasuries
Municipal
International Developed
Investment-Grade Credit/Corporate
Emerging Markets
High Yield
Short Duration or Rate Hedge
Decrease
Increase
Expected Changes to Fixed Income Sector
Allocations Over the Next Year
Proportion of institutions expecting allocation to:
Note: Based on 128 responses: 50 institutional funds, 37 investment managers, 27 RIAs, and 14 insurance companies in 2015. Source: Greenwich Associates 2015 U.S. Fixed Income ETF Study
•
Institutional portfolios
diversifying / shifting toward
specialty products, largely in
search of yield in low interest
rate environment.
•
Likely to see increasing
demand for new approaches,
such as „smart beta‟.
•
Role for fixed-income ETFs in
multi-asset class portfolios, a
growth segment.
Greenwich Associates
Large-scale trades are becoming increasingly common among institutional
investors.
Increasing Comfort Trading Fixed-Income ETFs
Note: Based on 60 respondents: 10 institutional funds, 21 RIAs, 22 investment managers, and 7 insurance companies in 2015. Source: Greenwich Associates 2015 U.S. Fixed Income ETF Study
12%
7%
31%
17%
33%
More than
$100 million
$51-$100
million
$11-$50
million
$6-$10 million $0-$5 million
Largest Single Trade Using a Fixed-Income ETF
15
92%
93%
98%
Comfortable
Trading ETFs
Satisfied with
Experience
Likelihood to
Trade Again
Experiential Feedback
Investor expectations suggest further expansion of ETFs in the years ahead.
Fixed-Income ETF Forecast
• About half of institutions not currently
using ETFs are considering use in the
next twelve months.
• Greatest growth channels: insurance
and asset managers.
•
Expect continuation of current trends:
Greater comfort / familiarity
Eroding concerns with greater
liquidity
Broader applications
Compliment to bonds
Replacement of derivatives
Note: 1Based on 58 respondents in 2015, 0% expected to decrease bond ETF use. 2Based on 11 respondents in 2015 who plan to increase use of bond ETFs in next 12 months.
Source: Greenwich Associates 2015 U.S. Fixed Income ETF Study
0%
Stay
the
Same
76%
Increase
24%
Expected Use of Bond ETFs Over Next 12 Months
Expected increases or decrease
1Of those expecting to increase
expected magnitude of change
245%
27%
18%
9%
16-20%
Over 20%
6-10%
1-5%
11-15%
Greenwich Associates
A select few have garnered the attention of institutional investors.
Leading Fixed-Income ETF Providers
• Matches exposure needed
• Liquidity / trading volume
• Expense ratio
• Performance / tracking error
• Fund company
• Benchmark used
• AUM
• Breadth of ETF offerings
12%
17%
22%
50%
Other
State
Street/SPDRs
Vanguard
iShares/Blackrock
Investment Mangers
Note: Based on 46 respondents expressing a preference: 8 institutional funds, 18 investment managers, 14 RIAs, and 6 insurance companies in 2015. Source: Greenwich Associates 2015 U.S. Fixed Income ETF Study
