Managing excess reserves or periodic cash flows efficiently is an essential element of high quality institutional portfolio management. When an investor has a large temporary cash position, the respective portfolio is likely to be tilted away from its target allocation to equities or fixed income. In a rising market, this could result in a cash drag and hence performance shortfalls relative to the benchmark. To overcome this drag on performance, investors can employ a cash equitisation strategy. The aim of this strategy is to remain fully invested while maintaining liquidity.
Global ETF assets under management 1
Launched the first US-listed ETF
Global number of ETF offerings 2
Exchange traded funds (ETFs) were initially created to provide institutional investors with a means to equitise these cash positions using a fund structure backed by physical securities (as opposed to using derivatives). Instead of having a significant cash position, investors can select an ETF that closely approximates their target market and risk exposure. This enables the investor to remain fully invested and minimise the risk of performance shortfalls in rising markets.
A cash equitisation strategy through ETFs is useful for institutional investors who are transitioning assets between managers. It remains a common rationale for ETF use, and is arguably more important than ever when yields on cash assets are close to zero.
While the use of ETFs for cash equitisation may be popular with overseas asset managers, Australian investors generally prefer using futures as a cash equitisation tool. Futures may offer a liquidity advantage, but using ETFs for all or part of a cash equitisation program is likely to enhance returns and provide better after-tax outcomes for investors.
Compared to futures, ETFs:
We launched the first US-listed ETF in 1993 as a cash equitisation vehicle for institutional investors. Since then, institutions remain some of the largest investors in ETFs, with usage continuing to expand across a wider range of investors and investment strategies.ETFs offer investors further benefits –they are low cost, simple, tax efficient and easy-to-access investments.
Understanding ETF Liquidity
One of the main advantages of ETFs is that they offer liquidity from two sources. From the surface, it may be obvious that there is liquidity as defined by the trading volume and bid/ask spread in the secondary market. Beneath this is another source of liquidity in the primary market that may often be missed.
1 Source: Morningstar, as of March 31, 2019.
2 Source: Morningstar, as of March 31, 2019.
Derivative investments may involve risks such as potential illiquidity of the markets and additional risk of loss of principal.