International exchange-traded funds have started to catch on with U.S. pension funds, which use them as proxies for international equity investments, to manage excess cash in their portfolios and to help in shifting from one manager to another.
U.S. pension funds that have invested in international ETFs include:
* the Pennsylvania Public School Employees Retirement System, Harrisburg, which owned $8 million in ETFs based on the MSCI EAFE index and $14.3 million in ETFs based on the MSCI Brazil index as of March 31;
* the $106 billion New York State Common Retirement Fund, Albany, which owned $15.5 million in ETFs based on the MSCI Taiwan index as of March 31; and
* the Texas Teachers Retirement System, Austin, which owned $41.8 million in ETFs based on the MSCI Taiwan index and $9 million in iShares based on the MSCI Japan index as of March 31.
"We use them to provide intramonth liquidity to the (international) portfolio," said Scott Seery, chief of international equity investments at the $88 billion Florida fund.
He explained 50% of the international portfolio is passively managed and is not available for trading daily. "At times when we're rebalancing, we need liquidity and ETFs provide that," said Mr. Seery. The fund also uses ETFs when it has to make short-term investments of cash.
Matthew Denbleyker, Asian trader for the $75 billion Texas Teachers fund, said owning ETFs "is a good way to invest idle cash and gain diversified exposure to international markets." Owning ETFs on the MSCI Taiwan index "gives us a broad diversified exposure" to Taiwan equities without having to buy stocks in individual companies. He added that owning ETFs on Japan "is a way to equitize our cash." The fund owns $1.6 billion in Japanese stocks.
The $23.2 billion Pennsylvania fund also has used ETFs to invest cash in its EAFE index portfolio, according to a statement from the fund's investment division.
Pennsylvania's external managers have traded MSCI Brazil ETFs, as well as some other country ETFs, according to the statement
Among the 35 international ETFs available, the iShare created by Barclays Global Investors, based on the EAFE, has had particularly strong growth. The EAFE iShares got the lion's share of U.S. ETF growth in the past year, amassing $3.8 billion in assets under management since it was launched a year ago, according to a report from Merrill Lynch & Co., New York.
The iShares based on the MSCI indexes dominate the international ETFs trading on U.S. markets; assets in the 23 ETFs BGI puts out based on MSCI indexes make up 90.7% of total international ETF assets.
State Street Global Advisors, Boston, is the only other firm now offering an international ETF in the United States. It offers an ETF based on the Dow Jones Global Titans index.
The Vanguard Group, Malvern, Pa., filed an application with the Securities and Exchange Commission to offer three international ETFs. One ETF is based on the MSCI Europe index and another on the MSCI Pacific index; the third is based on a custom index formed specifically for Vanguard, the MSCI Select Emerging Markets Free index, according to Rebecca Cohen, a spokeswoman for Vanguard.
Steven Schoenfeld, managing director and head of international equities at BGI, said BGI filed an application with the SEC to offer an emerging markets ETF - based on the standard MSCI Emerging Markets Free index - before Vanguard filed its request. Mr. Schoenfeld said certain "operational hurdles" exist with using the MSCI Emerging Markets Free index, but he believes they can be overcome.
FTSE Group, which offers many international ETFs in Europe and Japan based on its indexes, is exploring the possibility of offering international ETFs in the United States, according to Tim Tindall, a spokesman for FTSE Americas. Mr. Tindall said FTSE would do it only if it can offer unique products .
"The use of international ETFs is particularly helpful if (a pension fund) is in a transition and can use iShares to park cash," said Mr. Schoenfeld.
ETFs also can be helpful "if a pension fund is increasing its international allocation to 15% from 12%," said Mr. Schoenfeld. "It can take a while to hire all the active managers. The pension fund could put the additional allocation in EAFE iShares and take it out when it chooses managers," he added.
`Best way to invest cash'
James Thames, senior portfolio manager of Arrowstreet Capital LP, Cambridge, Mass., agreed international ETFs "are a cost-efficient way of maintaining a fully invested status," which his firm does with its international equity strategies.
"We would use them as cash builds up in an account; it's the best way to invest cash," added Mr. Thames.
Mr. Thames said his only complaint about the MSCI iShares is that they have "spotty liquidity." He said the iShares based on the EAFE and MSCI Japan indexes have good liquidity but the rest of them "are dramatically less liquid."
The use of international ETFs also are considered better than "the `d' word - derivatives," said Mr. Thames.