Greenwich Associates study predicts doubling of assets in liquid alt ETFs over next year
Liquid alternative portfolios held through ETFs will see their assets more than double in the next 12 months, as institutional investors push into the sector according to a new Greenwich Associates study, commissioned by IndexIQ.
The projection is based on feedback from 107 senior fund professionals at large US institutions, who also explained how and why institutions are adopting liquid alternatives - and liquid alt ETFs in particular—as a means of obtaining exposures to hedge funds, real estate, private equity, and other asset classes.
The study found that liquid alternative ETFs are a natural fit for institutional portfoios. “In particular, liquid alt ETFs have the potential to help institutional investors address several vexing challenges related to alternative investments, including the frequent transitions between alternative managers and the high costs and limited transparency of fund-of-funds allocations,” the report says.
Greenwich Associates comments that it is only in the last decade that relatively large numbers of institutions began using ETFs. “Generally, this occurred first in equity portfolios, where institutions initially experimented with ETFs as a tool for short-term tasks like transitioning between managers, making tactical adjustments to their portfolios or ‘equitizing’ cash. After getting good results, institutions took advantage of the inherent flexibility of the ETF structure to apply the funds in new and increasingly strategic ways.
“Today, US institutions use ETFs as a source of long-term and ‘core’ investment exposures while also employing the funds in higher-level functions like risk management. ETFs are growing in popularity in fixed income portfolios as well, where they are used for, among other things, liquidity enhancement.”
Within the approximately USD24 trillion North American institutional market (and USD45 trillion global institutional market), Greenwich Associates reveals that US institutions have invested slightly more than USD1 trillion in ETFs, an amount that the firm says represents roughly a quarter of the overall US ETF market.
Among institutions, family offices are the biggest contributors, with about USD560 billion invested in ETFs and average ETF allocations of 35 per cent of total assets. Public funds are next at USD188 billion in total ETF assets, followed by corporate funds at USD182 billion and endowments and foundations at USD132 billion.
“In terms of adoption rates, ETF use is most common among family offices and endowments and foundations. About a quarter of corporate funds invest in ETFs, as do more than 35 per cent of public funds. However, usage rates are increasing across institutions of all types. More than a quarter of institutions not currently using ETFs say they are at least somewhat likely to consider using ETFs in the next year. That share includes approximately 30 per cent of corporate and public funds, whose large asset bases would move the needle on institutional ETF investments with even small allocations,” the firm says.
Institutions participating in Greenwich Associates annual research named ETFs as their clear vehicle of choice for passive exposures. As such, one of themost common uses for ETFs in both equity and fixed income is as a replacement for active mutual funds, the firm says.
“Institutions are also using ETFs to replace positions in individual securities and derivatives used for active exposures. Meanwhile, ETFs are making up a growing share of passive portfolios, where they are being used as a replacement for passive mutual funds. Relative to passive mutual funds, institutions say ETFs can at times be easier to use, more liquid and cheaper.”
However, the researchers found that institutions are applying ETFs to an expanding list of short- and long-term portfolio functions across equities, fixed income, and even in commodities and real estate. The most common use for ETFs is making tactical adjustments to portfolios, to obtain strategic core investment exposures and for portfolio diversification.
“This versatility, combined with the continued shift of assets from active to passive strategies, has set ETFs on a solid growth trajectory,” the report says.
Meanwhile, the past decade has seen US institutions growing their allocation to alternative asset classes from an average of 19 per cent of total assets to 26 per cent, representing USD5 trillion in assets, and globally, some projections put institutional investments in alternative assets in the neighbourhood of USD15 trillion to USD20 trillion by 2020.
This has been led by US endowments and foundations, since David Swensen and Dean Takahashi developed what came to be known as the “Yale model” in the 1990s.
But while a range of institutions derive a series of important benefits from alternative asset classes, including portfolio diversification derived from a low correlation with traditional asset classes, alpha potential and enhanced income generation and protection, alternatives also come with a well-known set of drawbacks, the report says.
These include a lack of transparency, complexity, increased risk levels, higher fees and, of course, reduced liquidity.
Liquid alternatives are vehicles that deliver exposure to alternative asset classes with daily liquidity, often through closed-end funds, mutual funds and ETFs. Greenwich Associates estimates that today, liquid alts represent about 4 per cent of institutional assets, with average allocations among study participants ranging from a high of 6 per cent of total assets among public funds to a low of 2 per cent among corporate funds and OCIOs.
These allocations represent USD882 billion in institutional assets currently invested in liquid alts, including USD564 billion from public funds, USD182 billion from corporate funds, USD88 billion from endowments and foundations, and USD48 billion from family offices.
Hedge funds and real estate are the most popular categories for liquid alts, but 38 per cent of institutions in the study are using liquid alts in ‘other’ areas such as commodities, infrastructure, futures, private credit, and agriculture.
For most institutional investors, liquid alternative ETFs represent a relatively new and novel vehicle. Only about one in 10 institutions have experience investing in the funds. However, about the same share of institutions say they are actively researching liquid alt ETFs for possible use, and an even bigger proportion say they might consider investing in the funds in the next 12 months, according to the study.