Estimates of institutional investment in ETFs are not available. But a BGI report said the number of institutions using ETFs increased 41% globally — to 2,717 — during a three-year period ended Sept. 30, 2008, the latest date for which data are available.
Since the fourth quarter of 2007, the $81.9 billion Teacher Retirement System of Texas, Austin, has been steadily increasing its ETF holdings, which now account for as much as 5% of total assets.
One of the Texas fund's largest ETF exposures is in iShares MSCI Emerging Markets Index ETF, ranging between $500 million and $2 billion since late 2008. Other large holdings have been in iShares Russell 2000 Index ETF and iShares Dow Jones U.S. Real Estate ETF, said Curt Rogers, portfolio manager in the strategic research and risk management division.
The fund's internal managers primarily use ETFs for transitioning portfolios, tactical asset allocation and funding external mandates. For example, in outsourcing an emerging market portfolio to an external manager, funding might be in iShares MSCI Emerging Markets Index ETF instead of cash. “That gives the manager immediate exposure to the benchmark,” Mr. Rogers said. “They can then go buy and sell stocks they really want.
“ETFs will keep us busy, particularly in tactical asset allocation,” he added.
Other institutions reporting large ETF holdings as of June 30 include: the $49.7 billion Ohio State Teachers Retirement System; the $43.2 billion Commonwealth of Pennsylvania Public School Employees' Retirement System; the C$43 billion ($40.5 billion) Ontario Municipal Employees Retirement System; the $26 billion Harvard University endowment; and the $8 billion endowment of Massachusetts Institute of Technology.
At BGI's iShares, the institutional division has more than doubled in size over the past two years. Institutional clients account for about 40% of iShares' business, said Elizabeth Tennican, principal and head of institutional sales. (iShares will be an ETF subsidiary of BlackRock BGI once BlackRock Inc.'s acquisition of BGI is completed.)
It is difficult to gauge pension fund use because most funds access ETFs through their managers, Ms. Tennican said. Indeed, most institutions buying ETFs continue to be traditional money managers and hedge funds, which account for 88% of the total number of institutional investors in ETFs, according to the BGI report. But larger, internally managed pension funds, foundations and endowments give a glimpse of how institutions increasingly are using ETFs.
ETF holdings — in terms of assets — by pensions, foundations and endowments has more than doubled in the second quarter of 2007 compared with the second quarter of 2009, according to a separate BGI analysis using Securities and Exchange Commission filings on institutions' holdings.
“More recently there have been many cases in which (internal pension fund managers) are looking to use ETFs, rather than swaps, to implement an exposure to commodities,” BGI's Ms. Fuhr said. “ETFs offer more trading flexibility and limit counterparty risks” compared to implementing the same strategy through swaps, she added.
ETF providers are also working with institutions to develop new strategies. For example, iShares Peru and iShares Asia ex-Japan ETFs have been introduced as a result of institutional demand, sources said. Mr. Rogers of Texas Teachers added that fund officials there have been in discussions with ETF managers to develop “products that don't currently exist,” for example, in credit-related strategies.
The 80 billion Swedish kronor ($11.4 billion) AP Fonden 7, Stockholm, first used ETFs about two years ago in its Swedish equity strategy, which accounts for about 10% of total assets. The fund implements the beta portion of portfolio with passive mandates, run by State Street Global Advisors and Handelsbanken Asset Management, and uses ETFs to add alpha.
“We borrow and sell (the ETFs) in the open market, then buy other securities we believe will outperform the index” to obtain alpha, said Svante Linder, head of fund management. “One of the main advantages of the procedure is that we can still maintain a cash-neutral position in the process.”
Earlier this year, fund officials began rolling out the same beta/alpha separation strategy for portions of the global equity portfolio, Mr. Linder said.
ETF holdings at AP7 have totaled up to about $1 billion for certain highly liquid classes such as U.S. equity.
“We expect to increase our use of ETFs to a higher degree within our alpha-beta separation and as a tactical solution,” Mr. Linder said.
Manooj Mistry, head of db x-trackers ETFs UK (Deutsche Bank's ETFs division), said pension fund officials might prefer ETFs over separate accounts particularly when investing in the more esoteric asset classes such as country-specific emerging market equity.
“My experience is that (institutional investors) are moving more and more toward an asset allocation model in which they're trying generate returns with the right asset allocation strategy, and ETFs is the right sort of tool to do that,” Mr. Mistry said. “The degree varies and how (investors) use ETFs varies. It's still the tip of the iceberg, though, and there's plenty of growth ahead.”
Data Editor Aaron Cunningham contributed to this story.