EDHEC survey shows modest but growing use of ETFs by pension funds
EUROPE - European pension funds remain modest users of ETFs, but their participation is growing.
The EDHEC-Risk European ETF Survey 2010, unveiled at EDHEC-Risk's Institutional Day in Monaco, gives an insight into how ETFs are used by 192 respondents across Europe, 68% of which were institutional investors, of which 15% were pension funds (10% of the total).
A panel discussion and views from the conference fringe also suggested pension providers use ETFs differently from the core wealth and asset management client base.
The survey revealed that most respondents use ETFs to achieve buy-and-hold broad market exposure, rather than for tactical asset allocation (TAA) or diversification via style- or sector-specific vehicles.
Felix Goltz, EDHEC-Risk's head of applied research, said: "That was surprising, seeing that the big advantage is the liquidity they offer."
Goltz said the latest survey had attracted "many more" pension fund participants than previous ETF-user research, and on the discussion panel, Nick Greenwood, manager of the Royal Borough of Windsor and Maidenhead Pension Fund, and Staffan Sevón, CIO of Veritas Pension Insurance, said they tended to be tactical users.
Greenwood said that his fund had used private equity ETFs to achieve exposure while traditional limited partnerships were in their cash-drawing stages, and sometimes during transition management.
He added: "If I want a long-term buy-and-hold position, I will tend to go for a segregated account because I can get my TER lower than I can with an ETF.
"But for short-term tactical allocation, the advantage of an ETF is that I can time the allocation flexibly because I don't need to fill in forms or wait for prospectuses - I just phone my prime broker and ask him to buy us an ETF."
Sevón agreed that, while Veritas usually invests direct in securities, the liquidity of ETFs suited TAA.
"We do use futures, but they carry some 'political' risk," he said. "It would be much easier for me to say we'd lost €100m on an ETF than it would be if we lost the same amount on a futures contract."
In the broader survey, ETFs bested other types of passive exposure on the 10 criteria respondents were asked to consider.
Goltz said: "To a certain degree, they are replacing traditional index funds. There is clear competition between ETFs and futures, but total return swaps are rated much less favourably than either of those.
"Overall, ETFs outperform futures on costs, tracking error, liquidity and the seven other criteria considered by respondents. The breadth of the product range is an especially clear advantage over the futures market."
Still, while ETFs accounted for 57% of wealth management portfolios on average, they made up just 38% of institutional portfolios, including asset managers.
"This is probably because these users have wider choice over how they implement passive exposure," said Goltz.
The survey suggests 90% of ETF trading is now OTC, with more users employing 'advanced trading mechanisms', which can help investors benefit from their liquidity without incurring the full on-exchange transaction costs.
That finding chimed with Greenwood's practice in particular.
Perhaps the most notable finding was that, whereas equity ETF use has plateaued and even declined, the use of fixed income and commodity ETPs has increased markedly since the 2009 survey.
Sevón said Veritas used ETFs only for equities, and while Greenwood confirmed his fund had never used bond ETFs, he said his investment committee had identified some advantages in commodity products.
"Contango has been a big problem in our commodities exposure, and we have seen that a basket of ETCs can incur less contango cost than a futures exposure," he said.
Asked by IPE about their preference with regard to replication or swaps-based ETFs, Sevón said each product should be judged on its own merits rather than on its structure alone.
However, Greenwood said: "All other things being equal, I prefer full replication."
Two other pension fund users asked the same question by IPE on the fringe of the conference expressed strong preference for replication ETFs over synthetics, on the basis of transparency of investment risk exposure and minimisation of counterparty risk.