Asset owners could account for a quarter of exchange-traded fund usage globally in five years, a potentially giant leap from as low as 5% now, according to a senior executive with BlackRock Inc.'s iShares ETF business.
While the institutional-retail split in ETF usage is typically pegged at 50-50 in the U.S. and 80-20 in Europe and Asia, money managers account for the largest chunk of that institutional business, noted Stephen Cohen, London-based chief investment strategist for iShares EMEA and iShares international fixed-income business, on a recent trip to Singapore.
But the past 18 to 24 months have brought signs of a “sea change” in interest in ETFs among pension funds, insurance companies, sovereign wealth funds and central banks, even if the increase in actual usage is still picking up steam, said Mr. Cohen.
Transition management, tactical overlays and “liquidity sleeves” — where an institutional will hold ETFs that track its strategic asset allocation, in lieu of cash, to maintain liquidity with minimal performance drag — are all areas of growing interest among asset owners now, he said.
Among the three, transition management is the most common entry point for asset owners considering greater use of ETFs, said Mr. Cohen. “If their experience is good, they're more open to having a discussion about other ways to use ETFs.”
Meanwhile, growing interest in tactical asset allocation following the global financial crisis, combined with the ripple effects of regulatory changes, is providing another boost now for ETF usage, he said.
BlackRock is having “a lot of discussions with investors around blending different products” for tactical overlay purposes now as regulations affecting bank balance sheets, collateral management and swap counterparties have made ETFs appear, in many cases, as a less risky or complicated means of achieving a similar outcome, said Mr. Cohen.
And the attractiveness of ETFs in head-to-head matchups with derivatives isn't confined to tactical situations. Asset owners who have traditionally used futures as the low-cost way to get long-term exposure to markets such as the S&P 500 are finding their assumptions challenged by current market conditions, he said.
The "roll cost of futures has actually deteriorated dramatically over the last 18 months," becoming significantly more expensive, said Mr. Cohen. "What you're finding is that some of the historical assumptions about futures usage for long-term exposures aren't really where the reality is today," which has led to "a lot of conversations at the moment" with asset owners.
In earlier years, an asset owner would have owned a futures contract, and taken the non-margin money and invested it in cash somewhere, but "because of what's happening to cash rates and LIBOR rates, and what's happening with the futures roll becoming more expensive, it's not as efficient as it was," said Mr. Cohen.
"We're actually starting to see a lot of interest from … pension funds, insurance companies," especially for ETFs that provide exposure to the S&P 500 and other leading indexes, said Mr. Cohen, citing that demand as potentially "a big driver of institutional usage of ETFs in the next year."
Those asset owners will never turn to ETFs for the bulk of their investments, but because that institutional pool is so huge, even if a relatively modest fraction of their assets go to ETFs, they could account for a significant piece of the overall pie, he said.
For now, the bulk of asset owners are still exploring the different ways they can employ ETFs, but "we're seeing all types of institutions starting to use them now – definitely moving to action globally," he said.