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European institutional investors are increasingly turning to exchange traded funds (ETFs) as interest in smart beta strategies and multi-asset investment funds rises, a new study has found.

Greenwich Associates, the consultancy and research firm, interviewed 125 institutional investors for the study. Corporate pension funds and asset management firms were the most widely represented, followed by insurance companies and public pension funds.

The average ETF allocation among the institutions surveyed grew by 2.6 percentage points in 12 months to 10.3% of total assets in 2017.

The share of institutions that invested in smart beta ETFs increased 10 percentage points to 31% in two years and the share of European asset managers buying ETFs for use in multi-asset funds increased to around 80% in 2017 from 63% the year before.

ETFs were being introduced to “a long list of portfolio functions, both strategic and tactical,” according to the report. There had been strong take-up of fixed income ETFs, but ETF usage was also spreading into asset classes besides equities and fixed income.

There was a pronounced increase in adoption of commodity ETFs, for example, with one-third of the institutions participating in the study using these last year, up from 20% in 2016.

“After multiple years of regular use, European institutions have found ETFs to be simple, versatile and cost-effective tools, and they are ramping up their investments at a rapid clip,” said Andrew McCollum, managing director at Greenwich Associates.

Since their emergence as a prototype in Canada in 1990, the worldwide market for ETFs, which track anything from global indices to a commodity index, has swelled to more than $5trn (€4.2trn).

“While there might be some liquidity problems in the underlying market, the secondary market trades very well” [in times of market stress]

Armit Bhambra, head of UK retirement, BlackRock iShares

Investors – both retail and institutional – have been drawn by the relatively low total expense ratios available, which, according to ETFdb.com, can be as low as 3 basis points a year.

“Many of the conversations we have [with our institutional clients] are around costs,” said Armit Bhambra, head of UK retirement, iShares, part of BlackRock, the world’s biggest asset manager.

Of the institutional investors interviewed for the survey by Greenwich, BlackRock is employed as an ETF provider by nine out of 10 institutions. The report was written in collaboration with BlackRock iShares.

“[Investors] want something that is niche and more granular,” added Bhambra. “ETFs tend to be more niche than indexed mutual funds.”

According to Greenwich’s data, approximately 40% of institutions interviewed plans to increase allocation to ETFs over the next 12 months. Globally, annual inflows to ETFs could reach $300bn by 2020, the study found. 

Yet despite their growing popularity, questions remain over how ETFs would fare in a market downturn. Critics, including Paul Singer, founder of Elliott Management, the US hedge fund, have warned the vehicles remain untested in a more hostile economic environment. 

“What may have been a clever idea in its infancy has grown into a blob which is destructive to the growth-creating prospects of free-market capitalism,” Singer said last year.

However, iShare’s Bhambra said that as the ETF market has become larger it has undergone moments of market stress, not least during the volatility of last year. 

At those points, “while there might be some liquidity problems in the underlying market, the secondary market trades very well”, he said.

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