"Change often arrives in the company of mixed opinion," said Dalia Blass, director, division of investment management at the U.S. Securities and Exchange Commission, at a recently concluded Investment Company Institute conference. But when it comes to the ongoing shift to lower-cost investment vehicles, institutional investors continue to be of one mind. They are driving assets into low-cost exchange-traded funds in line with their investment objectives.
Over the past year, 98% of all ETF flows ($262 billion) went to products charging a management fee of 0.2% or lower, according to research firm XTF Inc. But perhaps even more telling for institutional investment trends in ETFs, 62% of flows over the past three years ($636 billion) went into low-cost products managed by BlackRock (BLK) Inc. (BLK), Vanguard Group or State Street Global Advisors and based on indexes from London Stock Exchange Group's FTSE Russell, MSCI Inc., S&P Dow Jones Indices LLC or Bloomberg LP.
"Benchmarking is essential to product choice," said Andrew McCollum, a managing director at Greenwich Associates LLC in Stamford, Conn. "And once the benchmark is set, fees are considered relative to other options."
The institutional ETF playing field, defined by index, assets and volume has split the market to the point that many issuers looking to gain an edge in the retail and adviser market are pushing fund fees as the primary metric of choice and publicity.
For example, in mid-March, J.P. Morgan Asset Management (JPM) launched a U.S. large/midcap equity ETF for an initial cost of just 0.02%. Earlier this year, student loan refinancing company Social Finance Inc. revealed plans to sponsor two equity ETFs with waiver-adjusted zero expense ratios. And a recently launched fund from Salt Financial LLP is looking to include a net 5-basis-point rebate for the first $100 million in assets via an amendment awaiting SEC approval.
In her address, Ms. Blass expressed concern "about what it will mean for investors — particularly Main Street investors — if the variety and choice offered by small and midsized asset managers becomes lost in a wave of consolidation and fee compression." And she has asked her staff to start a new outreach initiative targeted at small and midsized fund sponsors.
According to Deutsche Bank Research, institutional investors have shown declining interest in new product launches for the past several years, utilizing 89% of the U.S. ETF product set in 2017 from more than 93% in 2014. Deutsche Bank defines institutional investors to include all 13F filers, accounting for 60% of all ETF ownership by assets at the end of 2017.
Pension funds are the pickiest ETF investors, disclosing use of only about 180 U.S.-listed ETFs between 2014 and 2017. Of the top 30 ETFs owned by pension funds, 19 are issued by BlackRock (BLK), six from SSGA and four from Vanguard.
"The management fee should be commensurate with the value delivered and the cost to service the fund," said Noel Archard, global head of SPDR product for SSGA in Boston, describing his firm's approach to setting price.
Mr. Archard said that his team evaluates expenses every few months and annually with the fund boards. "The fund boards provide an independent check on that fee," he said. Adding that several factors go in to the discipline of setting fees. "Does the product stand alone or is it part of a factor or fixed-income suite? What are the expectations for growth? What is the potential change in variable cost?"
"The fee is a small part of our decision," says Syed Haque, head of public markets for UPS Investment Group in Atlanta. "We don't even hear the noise (in the retail market)."
Mr. Haque estimates that roughly 10% of the United Parcel Service Inc.'s defined benefit plans' $15 billion equity portfolios are invested in ETFs, primarily for strategic or tactical asset allocation decisions, to overweight regions or sectors or to employ a factor-based tilt. His view backs up recent survey work by Greenwich Associates, with 72% of investors surveyed citing tactical adjustments as a reason for utilizing ETFs. The survey also found that 33% of institutions using smart beta or factor ETFs intend to increase usage over the coming year, with 38% of those respondents expecting a 10% or greater increase in usage.
"Factor investing is hot again, and definitely gaining traction in the institutional market," said Greenwich Associates' Mr. McCollum. And March also offered a confluence of these trends when DWS Group GmbH & Co. launched a U.S. ESG-focused ETF at an initial expense ratio of 0.10%. The $868 million fund was developed in coordination with Ilmarinen Mutual Pension Insurance Co. of Finland.