Trends in Institutional Investor Use of Fixed Income ETFs. Presenter: ANDREW MCCOLLUM Partner & Managing Director Greenwich Associates

Transcription

1 Trends in Institutional Investor Use of Fixed Income ETFs Presenter: ANDREW MCCOLLUM Partner & Managing Director

2 Table of Contents Role in Institutional Portfolios Drivers of Growth Institutional Fixed-Income ETF Outlook Conclusions 2

3 Role in Institutional Portfolios 3

4 The Appeal of ETFs in the Institutional Market Direct feedback from the institutional community. We have found a lot of new innovative products are available in ETF form. RIA It started out as a tactical tool to temporarily hold cash; over time our use has evolved into permanent holdings. Insurance company ETFs allow me to diversify exposure to style, market capitalization and sectors that I would not be able to efficiently achieve trading individual names. The key word is diversification. Asset manager We use ETFs to fill out when we can t find individual bonds. Investment manager At times active managers have difficulty beating their benchmarks and ETFs are considerably less expensive. Pension fund We are making greater use of ETFs as we delve into other parts of the market that we would not access with individual stocks, such as European, international and emerging markets. Over time, we will make even greater use of ETFs as we try to tap additional areas of the market. RIA 4

5 The Root Cause of Growth Regulatory and policy shifts upended fixed income markets, spelling uncertainty for its participants. Fed Policy U.S. Federal Reserve - Low interest rate environment put in place to inject liquidity and help spur economic growth Regulatory Shifts Dodd-Frank Limited size of financial institutions and lowered tolerance for risk market-wide Basel III Heightened liquidity standards for financial institutions Dramatic increase of bond issuances in pursuit of cheap money flooded primary markets Confluence of regulatory restrictions constricted liquidity in secondary markets 5

6 Illiquidity in Fixed Income Markets Increased regulatory pressure on financial institutions and a flooded bond market combined for depleted dealer inventories, high costs, and volatility. Investor Concerns When should I buy the bond? Will I have trouble offloading the bond? When would I expect to sell? Is that feasible? More Challenging Fixed Income Trading Environment Over the Past Two Years Challenges in Trading, Liquidity or Sourcing Securities in Fixed Income Markets 34% Have Challenges Affected Investment Process? No 48% Yes 52% How do I recalibrate my portfolio to adjust for this difficulty? How do I offset the increased cost executing trades? About the Same Less Challenging 61% 5% Note: Based on 119 respondents in Source: 2015 U.S. Fixed Income ETF Study 6

7 Drivers of Growth 7

8 Many Tools in the Toolkit Investors employ Fixed-Income ETFs for a variety of applications. Fixed-Income ETF Applications by Institution Type Insurers Investment Managers RIAs Institutional Funds 57% 57% 73% 73% 64% 62% 60% 80% 76% 76% 71% 70% 64% 59% 57% 43% 43% 45% 38% 32% 33% 27% 43% 41% 30% 40% 10% 10% 19% 20% 14% 0% ETF Overlay/Liquidity Sleeve Transitions Hedging Cash Equitization/Interim Beta Tactical Adjustments Portfolio Completion Rebalancing Passive Exposure in the Core Note: Based on 60 respondents: 10 institutional funds, 21 RIAs, 22 investment managers, and 7 insurance companies in Source: 2015 U.S. Fixed Income ETF Study 8

9 Broadening from Tactical to Strategic Use Current ETF users are broadening their deployment of fixed-income ETFs from tactical applications to more strategic portfolios uses. % of Fixed-Income ETF Assets Considered Strategic Average Fixed-Income ETF Holding Period % 70% 62% 62% % 58% 63% 46% % Source: U.S. Exchange-Traded Funds Study. Note: Based on 201 responses: 49 institutional funds, 19 investment consultants, 31 insurance companies, 70 RIAs, and 32 asset managers in Percentages may not add to 100 due to respondents preferring not to answer.. 1 Year or More 9

10 Serving as a Complement to Bonds Healthy trading volumes and asset growth positions ETFs as complements to traditional fixed income securities. Five Largest Credit ETFs 75x Positive Velocity 17x Reasons for Using Bond ETFs Alongside Individual Bonds Ease of Exposure More Liquidity Depends on Business/Client Requirement 19% 34% 38% Overall Investment Grade and High-Yield Credit Market Negative Velocity 1.7x 2.1x Trade Volume Growth Since 2008 Total Asset Growth Since 2008 Diversification Use for Duration Management/Transition Tactical Asset Allocation Use of a Placeholder/Replacement Good Value/Low Cost Easy to Use/Access Ability to Use Instead of Individual Bonds 19% 16% 9% 9% 6% 6% 3% Source: 2015 U.S. Fixed Income ETF Study Fund assets and trading volume compiled from Bloomberg. Trading volumes based on cumulative monthly ADV from the period 12/31/ /31/2014. Five largest credit ETFs determined by ranking the total net asset value of the funds as of 12/31/14. 10

11 More Cost Effective Beta than Derivatives Given liquidity issues, investors have looked elsewhere for fixed income exposure, primarily derivatives. ETFs offer another option to investors using derivatives to gain fixed income exposure. 61% believe S&P 500 ETF provides more cost effective beta exposure than S&P 500 future. Bond ETFs as Substitutes for Derivatives Use of Derivatives (Credit Default Swaps, Treasury Futures, Total Return Swaps) to Gain Fixed Income Exposure 1 Would Consider Using Fixed- Income ETFs as Alternative to Gain Fixed Income Exposure 2 No 42% 43% have shifted to ETF from derivatives in the past year. No 72% Yes 28% Yes 58% 15% will replace existing fixed income futures position with ETF in the next year. Note: 1 Based on 128 respondents in Based on 36 respondents in 2015 who use derivatives Source: 2015 U.S. Fixed Income ETF Study 11

12 Barriers to ETF Adoption Investors not currently using fixed-income ETFs cite several common themes behind their hesitations. Despite asset growth, perceptions of limited liquidity still persist. Specific events add fuel to concerns about liquidity when it is needed most. Reasons Institutions Don t Currently Use Fixed-Income ETFs Low Trading Volumes or Assets Internal Limits Constant Maturity Profile of Many ETFs vs. Declining Maturity of Bonds 28% 27% 48% Internal rules and guidelines have yet to evolve at certain organizations. 40% of those who feel uncomfortable trading ETFs attribute that feeling to a lack of understanding of the product. Investment Guidelines Expenses Lack of Understanding/Familiarity Regulatory Limits ETFs Not Supported on Trading/PM Platform 20% 15% 12% 8% 8% Note: Based on 60 respondents: 10 institutional funds, 22 investment managers. 21 RIAs, and 7 insurance companies in Source: 2015 U.S. Fixed Income ETF Study 12

13 Institutional Fixed-Income ETF Outlook 13

14 Shifting Fixed Income Dynamics ETF demand likely to mirror broader shifts in institutional fixed income product demand. Institutional portfolios diversifying / shifting toward specialty products, largely in search of yield in low interest rate environment. Likely to see increasing demand for new approaches, such as smart beta. Expected Changes to Fixed Income Sector Allocations Over the Next Year Proportion of institutions expecting allocation to: Short Duration or Rate Hedge High Yield Emerging Markets Investment-Grade Credit/Corporate International Developed Decrease 7% 9% 5% 9% 9% Increase 20% 15% 24% 23% 22% Role for fixed-income ETFs in multi-asset class portfolios, a growth segment. Municipal U.S. Treasuries 19% 1% 14% 14% Asset-Backed 4% 9% Note: Based on 128 responses: 50 institutional funds, 37 investment managers, 27 RIAs, and 14 insurance companies in Source: 2015 U.S. Fixed Income ETF Study 14

15 Increasing Comfort Trading Fixed-Income ETFs Large-scale trades are becoming increasingly common among institutional investors. Experiential Feedback Largest Single Trade Using a Fixed-Income ETF Likelihood to Trade Again 98% 31% 33% Satisfied with Experience 93% 17% 12% Comfortable Trading ETFs 92% 7% More than $100 million $51-$100 million $11-$50 million $6-$10 million $0-$5 million Note: Based on 60 respondents: 10 institutional funds, 21 RIAs, 22 investment managers, and 7 insurance companies in Source: 2015 U.S. Fixed Income ETF Study 15

16 Fixed-Income ETF Forecast Investor expectations suggest further expansion of ETFs in the years ahead. Expected Use of Bond ETFs Over Next 12 Months Expected increases or decrease 1 Of those expecting to increase expected magnitude of change 2 About half of institutions not currently using ETFs are considering use in the next twelve months. Over 20% 16-20% 9% 18% Greatest growth channels: insurance and asset managers. Stay the Same 76% Increase 24% 11-15% 0% 6-10% 1-5% 27% 45% Expect continuation of current trends: Greater comfort / familiarity Eroding concerns with greater liquidity Broader applications Compliment to bonds Replacement of derivatives Note: 1 Based on 58 respondents in 2015, 0% expected to decrease bond ETF use. 2 Based on 11 respondents in 2015 who plan to increase use of bond ETFs in next 12 months. Source: 2015 U.S. Fixed Income ETF Study 16

17 Leading Fixed-Income ETF Providers A select few have garnered the attention of institutional investors. Key Selection Criteria Preferred Fixed-Income ETF Provider Matches exposure needed Liquidity / trading volume Expense ratio Performance / tracking error ishares/blackrock Vanguard State Street/SPDRs Other Investment Mangers 22% 17% 12% 50% Fund company Institutional Funds Benchmark used ishares/blackrock 50% AUM Vanguard 25% Breadth of ETF offerings PIMCO 13% Other 13% Note: Based on 46 respondents expressing a preference: 8 institutional funds, 18 investment managers, 14 RIAs, and 6 insurance companies in Source: 2015 U.S. Fixed Income ETF Study 17

18 Conclusions 18

19 Key Takeaways 1 No change to growth drivers Liquidity challenges will persist. Awareness / comfort levels will rise. Hesitations about liquidity will erode. 2 Institutional market remains in growth phase Shifting uses from tactical to strategic. A liquidity complement to bonds. A replacement for derivatives. 3 Growth trends to watch Broadening use in insurance channel. Product innovation to meet client needs. Growth of fixed-income ETFs in global markets. 19

20 Contact Information UNITED STATES CANADA JAPAN 6 High Ridge Park Stamford, CT USA Tel: Javelin Strategy & Research 4301 Hacienda Drive, Suite 550 Pleasanton, CA USA Tel: Canada 14 Prince Arthur Avenue Suite 208 Toronto, Ontario Canada M5R 1A9 Tel: Sheppard Avenue East, Suite 201 Toronto, Ontario Canada M2K 2S5 Tel: Japan K.K Akasaka Minato-ku, Tokyo Japan Tel: ASIA Singapore 137 Amoy Street #03-05 Far East Square Singapore, Tel: EUROPE UK 90 Basinghall Street 1st Floor London, EC2V 5AY United Kingdom Tel: Andrew McCollum Managing Director Direct: andrew.mccollum@greenwich.com 2015, LLC. Javelin Strategy & Research is a division of. All rights reserved. No portion of these materials may be copied, reproduced, distributed or transmitted, electronically or otherwise, to external parties or publicly without the permission of, LLC., Competitive Challenges, Greenwich Quality Index, Greenwich ACCESS TM, Greenwich AIM TM, and Greenwich Reports are registered marks of, LLC. may also have rights in certain other marks used in these materials. 20

21 Trends in Institutional Investor Use of Fixed Income ETFs Q&A

22 Thank You