Contrary to their reputation as an vehicle designed for retail investors, especially individuals with relatively small accounts, ETFs are finding increasing favor with large institutional investors. Indeed, ETFs represented 24.8% of institutional asset managers' portfolios by late 2018, up from 18.5% in 2017, according to a survey conducted by financial data firm Greenwich Associates, as reported in Business Insider. Three of the major reasons for this trend are summarized n the table below.
Why Big Investors Love ETFs
- Low cost tool for managing risk
- Poor performance of active investment management
- Added ease in shifting tactics and rebalancing portfolios
Source: Business Insider
Significance for Investors
Greenwich Associates surveyed 181 investment managers, institutional funds, insurance companies, investment advisors, and other entities. Most of them had $5 billion or more in assets under management (AUM).
Risk management. The institutional investors surveyed by Greenwich Associates named managing risk as their number one priority by far. Among the biggest contributors to market risk right now are the U.S.-China trade conflict, Brexit, and the uncertain economic outlook in China. Respondents cited the ease and low cost of using ETFs as a risk management tool.
Poor performance of active managers. The poor performance of active managers in the volatile market of late 2018, an environment that was supposed to be ideal for them, convinced many respondents to switch to index-tracking ETFs that outperformed the stock pickers. An increasing number of institutional investors also are switching to ETFs in place of index mutual funds and individual stocks.
Passively-managed large cap equity mutual funds and ETFs now control more assets than actively-managed funds. This is largely the result of deteriorating performance by active managers, according to research by Morningstar.
Indeed, a key impetus for the rapid growth of ETFs during the past decade was the failure of actively-managed funds to protect investors during the financial crisis of 2008 and the recession of 2007 to 2009. "People were disappointed that active management didn't help them. They said they'd be able to protect you on the downside and a lot of managers didn't deliver on that promise," as Alex Bryan, director of passive strategies research at Morningstar, told CNBC.
Facilitating portfolio shifts. The increasingly wide variety of investment themes that ETFs follow are making them attractive means for establishing and changing core allocations, getting international diversification, and even managing cash and liquidity. ETFs also are gaining popularity as a means to make fixed income investments.
Rapid growth. U.S.-listed ETFs controlled about $3.75 trillion of assets as of the end of Feb. 2019, per ETF.com. This is more than seven times their value in 2008. Retail investors have been trading individual stocks for ETFs at an accelerating rate, per analysis by Bank of America Merrill Lynch cited by CNBC.
The trend towards passive investment management, increasingly through ETFs, is gaining momentum. With big institutional investors now embracing those trends, active managers are under escalating pressure to prove their worth.