The importance of liquidity management cannot be understated. Illiquidity can lead to several problems and after the market turmoil of 2008, many institutions revisited their processes for managing liquidity.
One approach has been to build ‘liquidity buffers’ into the management of institutional portfolios. The aim of this strategy is to increase liquidity in the overall asset allocation, without changing the allocation.
Global ETF assets under management 1
Launched the first US-listed ETF
Global number of ETF offerings 2
Exchange traded funds (ETFs) are a valuable tool for liquidity management. In this case, a percentage of each asset class is allocated to a liquid and easily tradable ETF that tracks the relevant asset class benchmark, removing the need to make regular applications or redemptions to the various active or indexed fund managers used by the investor.
The ETF is then used as a liquidity source to address ongoing cash flow requirements. Essentially, this source of liquidity allows for the efficient rebalancing of trades as well as tactical asset allocation.
An Alternative Source of Liquidity
One of the key characteristics of ETFs is the liquidity of the ETF itself, partly due to the liquidity of the ETF shares and partly due to the liquidity of the underlying investments. This feature has been attracting a growing number of investors.
For nearly a decade now, concerns about liquidity in the markets have prompted institutional investors around the world to seek out alternative liquidity sources. For many, ETFs have filled that role.
Between October and December 2018, a new US ETFs survey from Greenwich Associates canvassed 181 institutional investors, including 37 institutional funds, 33 insurance companies/insurance company asset managers, 56 registered investment advisors and 11 investment consultants. The study highlights that 83% of the investors and 90% of the asset managers cite liquidity as a primary reason for investing in bond ETFs.3
Within equities, the study also noted that while institutions cite they are investing in equity ETFs first and foremost for their ease of use within portfolios, 81% also stated liquidity as a primary reason for using the funds.
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.
The role of market makers and authorised participants in the ETF ecosystem
Liquidity is a key feature of ETFs. Due to their open-end structure, ETFs offer liquidity through both a primary and a secondary market. Authorised Participants and Market Makers play a key role in providing ETF liquidity. Usually, Market Makers are also Authorised Participants.
1Source: Morningstar, as of March 31, 2019.
2Source: Morningstar, as of March 31, 2019.
3Source: ETFs: U.S. Institutions’ New Tool of Choice for Portfolio Construction, Greenwich Associates, Q1 2019