Institutional investors may find they have gaps in their portfolios, perhaps with little or no exposure to certain asset classes, market segments or sectors. For example, investors who are invested in a broad-based emerging market index have become increasingly large capitalisation focused over the past several years. This is mostly due to the construction methodology for broad-based emerging market indices, which results in a heavy focus on mainly large- to mid-capitalised companies and no exposure to small capitalisation companies. In order to manage the risk of a concentrated investment position, investors may consider a portfolio completion strategy. This strategy aims to fill any asset allocation holes, without engaging a new investment manager.
Global ETF assets under management 1
Launched the first US-listed ETF
Global number of ETF offerings 2
Exchange traded funds (ETFs) enable investors to fill up the gaps in their portfolios and match a benchmark’s asset allocation, until the portfolio can be rebalanced to the desired allocation. The result is an increase in the diversification of a portfolio that's heavily weighted towards one part of the market. Portfolio completion through ETFs can be deployed either strategically or tactically, and can be useful for an investo rwho may seek to quickly gain exposure to specific sectors, styles or asset classes without having to obtain the prerequisite expertise in these areas.
Access to Niche Sectors
Some niche asset class segments, such as small capitalisation companies in emerging markets, are not widely available in pooled index funds and futures contracts are largely non-existent. This is where the breadth of ETFs on offer can be advantageous, with thousands of indexes available: at the end of December 2018, there were 7,199 exchange traded products (ETPs - which include ETFs and exchange traded notes), available globally3, providing exposure to almost every asset class an institutional investor could want. Beyond the core exposures to major indices, investors can use ETFs to access sectors and sub-sectors.
While accessing specific segments of the market are part of a portfolio completion strategy, institutional investors that would like to access difficult-to-reach market segment may also like to consider an asset class exposure strategy.
Investors Increasingly Use ETFs for Portfolio Completion
In 2018, US institutional investors increased their use of ETFs for a portfolio completion strategy.
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 57% of institutional investors cite portfolio completion as a primary application for ETFs4, up from 52% of participants in the previous year. Study participants say one of the main benefits of investingin ETFs is an ease of use that allows them to quickly and seamlessly integrate ETFs into strategies across portfolios and asset classes.
We launched the industry’s 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: Morningstar, as at 31 December 2018
4Source: ETFs: U.S. Institutions’ New Tool of Choice for Portfolio Construction, Greenwich Associates, Q1 2019