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ETF Market: Canadian Institutional Investors Are Leading The Way

ETF Market: Canadian Institutional Investors Are Leading The Way

The ETF market continues to evolve, especially among institutional investors. Warren Collier discusses how Canada is leading the way.

Canadians often sell themselves short when it comes to giving themselves credit, but when it comes to the evolution of ETFs, we should claim some bragging rights. After all, it was right here in Canada that the world’s first ETF was born. Over the following 25 years, more and more investors around the world have realized the potential benefits and uses of ETFs. Yet today, the ETF market continues to evolve, especially among institutional investors. And the good news is that Canada is still leading the way.

For the past few years, BlackRock Canada has sponsored a survey of Canadian institutions and asset managers by Greenwich Associates, and the most recent study shows institutional investors are holding a record level of assets in ETFs. Institutions report that they have 21 per cent of total assets invested in ETFs; among asset managers who invest for institutions, the level is even higher, at more than 25 per cent. What’s more, almost a third of investors’ surveyed plan to increase their allocations to ETFs in the coming year.

This is not really surprising to us given our iShares ETF business, since we have seen institutional ETF use steadily soar as investors become more familiar with the funds’ potential benefits of liquidity, convenience and cost-efficiency among them. What’s perhaps more interesting about this year’s Greenwich survey, though, is the level of sophistication it reveals in the way institutional investors are using ETFs.

First and foremost, from the study, it’s clear ETFs have become established as central pieces of institutions’ strategies. This is a remarkable shift. Traditionally, institutional investors used ETFs for what we call “tactical allocations,” employing the funds during periods of portfolio rebalancing or for transition between asset managers. Now, however, most institutional use is what we would classify as “strategic,” helping investors achieve portfolio diversification or core exposures.

According to the Greenwich study, two-thirds of Canadian institutional ETF assets fall into the strategic category. They are also holding on to their ETFs longer, with nearly half of reporting institutions saying they hold the funds for at least two years on average. That’s up from less than a third last year, and another signal of the growing strategic importance of ETFs for institutions today.

The Greenwich study also tracks what kinds of ETFs institutions are using, and here we’re seeing yet another sign of the evolving sophistication of Canadian investors. While traditionally institutions have used ETFs to gain exposure to equities, we’re seeing more and more of them turning to the funds for their fixed income needs. Two years ago, only 45 per cent of institutions surveyed used fixed-income ETFs; last year, about half did. This year, almost 70 per cent of Canadian institutions are employing FI ETFs.

ETF Market - Canadian Institutional Investors

That is phenomenal growth, and it’s being driven in large part by the growing recognition that ETFs can provide a convenient, cost-efficient and low-risk alternative to the traditional method of gaining fixed income exposures (i.e. buying and selling bonds directly).

The fact is, the old way of doing things has become more difficult for investors since 2008 financial crisis. New regulations designed to mitigate systemic financial risk are impacting banks and bond dealers, the traditional providers of liquidity in the bond market. Meanwhile, low interest rates are driving a fragmented marketplace for bonds. Both of these factors are leading to increased liquidity pressures in fixed income. By comparison, fixed income ETFs provide secondary-market liquidity, along with price transparency and ease of transactions. According to the Greenwich study, the primary reasons institutions have for using bond ETFs – cited by 95 per cent of respondents – are convenience and liquidity.

Not only are Canadian institutions embracing fixed income ETFs, but they are also leading the rest of the world in embracing innovation. According to the Greenwich study, nearly half of Canadian institutions are now employing smart beta ETFs, compared with just a quarter of U.S. institutional investors. Even more telling, 44 per cent of institutions in Canada use smart beta funds in fixed income, compared with just five per cent in the United States.

You can read the full Greenwich report here for even more insights into Canadian institutional investors and their approach to exchange-traded funds. But the big takeaway for me is that, 25 years after it all started, Canada is still playing a lead role in the evolving story of ETFs.

Warren Collier is a Managing Director and Head of iShares in Canada. He is a regular contributor to The Blog and you can find more of his posts here.

ETF Market: Canadian Institutional Investors Are Leading The Way by Warren Collier, BlackRock

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