Institutions not afraid to move beyond biggest players

The three largest exchange-traded fund issuers — BlackRock Inc., Vanguard Group Inc. and State Street Global Advisors — command 80% of ETF assets under management in the U.S.

Such dominant positions in both “plain-vanilla” stock and bond index exposures, as well as some core factors, have created a challenging environment for large and small asset managers looking to compete in a cost-conscious market.

Yet, according to year-end data from FactSet Research Systems Inc., Norwalk, Conn., institutional investors are still willing to look beyond the Big 3 for unique products that answer a specific investment challenge. FactSet analyzed recent 13F filings from pension funds, endowments, foundations, insurance companies and sovereign wealth funds and identified 13 exchange-traded products with greater than $50 million in institutional assets.

“Simplicity is a factor here,” said Elisabeth Kashner, director of ETF research at FactSet in San Francisco. She pointed specifically to the use of Deutsche X-trackers MSCI Japan Hedged Equity. Pension funds and similar institutions held 44%, or $921 million, of assets in the ETF as of Dec. 31 vs. 2%, or $168 million of assets in the WisdomTree Japan Hedged Equity ETF.

The WisdomTree ETF, which offers a currency hedge on a dividend-weighted index, has six times the average daily trading volume and eight times the assets compared to Deutsche Bank's cap-weighted product, benchmarked to an MSCI index more likely to be familiar to chief investment officers and investment committees.

Ms. Kashner also observed higher-than-expected usage of PowerShares QQQ, the very liquid, 18-year-old product that tracks the Nasdaq 100 index. Given there are more targeted sector ETFs on the market, gaining more investment precision by swapping out of QQQ could be relatively seamless given the lack of tax consequences, she said. QQQ, however, has liquid futures and options markets that help to support continued usage of the ETF.

While only a snapshot at the December quarter end, the data also reveal a level of comfort in holding a significant portion of one ETF. For the Deutsche X-trackers USD High Yield Corporate Bond, launched in early December, the Texas Employees Retirement System disclosed it held nearly 80% of the $136 million fund. One of the pioneers among pension funds in unlocking bond liquidity through ETFs, the Texas retirement system once used ETFs to facilitate a $2.8 billion liquidation of investment-grade bonds.

Based on 13F data, the holding of the Deutsche ETF was accompanied by a corresponding reduction in Texas' holding of iShares iBoxx $ High Yield Corporate Bond. The Deutsche fund launched with an 0.25% expense ratio compared to 0.5% for the $18 billion BlackRock offering.

“Our approach with the institutional community is highly consultative,” said Fiona Bassett, head of passive asset management, Americas, for Deutsche Asset Management in New York. “This starts with the design of investment solutions and extends to encompass thought leadership, capital markets, portfolio management and client servicing and reporting — so that we can provide the level of service that is expected by these clients.”

The implementation of currency-hedged products, Ms. Bassett pointed out, is one that takes advantage of Deutsche Bank's global resources in the consideration of portfolio construction and trading.

Also notable in the data is the sway of specialty, first-to-market products from VanEck and WisdomTree, despite challenges from other issuers with similar products. “They have honed their expertise to minimize tracking error,” said Larry Petrone, Boston-based director of product research and consulting at DST kasina. “And for institutional investors, they don't need "on-screen' liquidity or observed volume to understand the value in a particular product.”

For example, VanEck Vectors Russia, a $2.6 billion 10-year old ETF that invests in 28-listed companies on the Moscow Exchange, is 7.4% held by insurers and pension plans. And Charles Schwab's lineup of low-cost market-cap weighted ETFs has attracted insurance managers in both international equity and U.S. real estate investment trusts.

Given the often transient nature of some large institutional ETF holdings — including those held intraquarter, positions held by trusts and advisers, as well as those by non-reporting entities — 13F filings offer an incomplete picture of ETF usage by pension and endowment investors, among others.

Overall, the year-end data suggest roughly 3% of U.S. ETF assets managed by Vanguard, BlackRock and SSGA are held by regularly reporting pension funds, endowments, foundations, insurance companies and sovereign wealth funds in individual ETF holdings greater than $50 million.