ETFs hit the big time as institutional investors’ appetite for the funds grow

More active money managers are looking to launch exchange-traded funds as institutional investors’ appetite for the funds continues to grow.
T. Rowe Price Group Inc., Legg Mason Inc., Principal Global Investors and Goldman Sachs Asset Management all have filed with the Securities and Exchange Commission to offer ETFs, both passive and active. Other firms, such as New York Life Investment Management and Janus Capital Group Inc., have recently acquired ETF shops to enter that arena.
Moving in a slightly different direction, Navigate Fund Solutions, a subsidiary of money manager Eaton Vance Corp., is offering active non-transparent ETFs, called exchange-traded managed funds. The SEC granted Eaton Vance permission to offer ETMFs in November. To date, Eaton Vance’s ETMFs are the first — and only — active non-transparent exchange-traded products that the SEC has approved.
“ETF usage overall is definitely being driven in large part by institutions,” said Justin R. White, a partner with money manager consultant Casey Quirk & Associates. “Many are using them to gain exposure in places they haven’t been exposed to before.”
Mr. White noted institutional investors appreciate ETFs’ “ability to quickly access exposure to an index or commodity that’s not easily investible.”

Read more: Why ETFs are gaining pension plan exposure

The new entrants have some catching up to do. Data from ETF.com show that as of Aug. 17, the top three ETF providers — BlackRock Inc., Vanguard Group Inc. and State Street Global Advisors — account for 66% of the market, with a combined total of $1.71 trillion in ETFs.
A recent Pensions & Investments survey showed that 34% of officials at defined benefit plans, foundations and endowments say they use ETFs or exchange-traded notes. Of those, 25% said they plan to increase their usage. About 14% of non-users surveyed said it’s “somewhat likely” they would begin to invest via ETFs or ETNs within the next year.
Another report, released by PricewaterhouseCoopers in January, found the total ETF market is predicted to grow 6% per year, hitting $5 trillion by 2020 from the current $2.6 trillion.
TRANSPARENCY, TAX EFFICIENCY
“Investors have started to show a preference for ETFs for a number of reasons,” said Thomas K. Hoops, executive vice president and head of business development at Legg Mason Inc. “They like the transparency, the tax-efficiency, and the ability to get into or out of the strategy intra-day.”
Mr. Hoops added he believes that ETFs, which are typically used for market cap-weighted passive strategies, can be used to take advantage of additional approaches, such as smart beta.
“We also view the ETF as another vehicle to access our strategies,” he explained.
Not only has Legg Mason filed to offer ETFs in the future — Mr. Hoops declined to give a time frame — but the firm in February also recruited two executives from Vanguard Group to lead its new ETF strategies.
Mr. Hoops said Legg Mason’s managing director and head of ETF product management, Rick Genoni, and ETF product management director, Brandon Clark, will both “help finalize the strategy and help execute it as (they) move forward.”
While firms like Legg Mason, T. Rowe Price and GSAM have yet to launch ETFs, Principal Global Investors launched its first — an active multiasset income strategy — in July.
Paul Kim, managing director and head of ETFs for Principal Global Investors, said he believes “now’s a great time” to get into the ETF business, because the business is primed to grow.
“We want to be part of that growth,” Mr. Kim said.
He said money managers including Principal are thinking about ETFs as both an offensive and defensive offering.
On the offensive side, the funds are seen as a useful growth tool. On the defensive side, managers fear that not having an ETF could hurt their business.
Money managers, said Mr. Kim, are “seeing a lot of outflows from active equity mutual funds and inflows into passive equity ETFs. That worries a lot of managers; if they don’t have an ETF presence that can be seen as a threat.
“As a global manager, we need to have an ETF strategy,” he added.
COMPETITIVE FOR INSTITUTIONS
“ETFs have now become a very competitive tool (for institutions) to access beta on par with derivatives and mutual funds,” Mr. Kim added. “We still haven’t seen a lot of adoption of active ETFs in the institutional space, but we think that, too, will grow over time.”
There’s currently $29 million in the multiasset income ETF. Principal also plans to release passive strategies in the future.
Macrae Sykes, an analyst at Gabelli & Co. Inc., noted the increased interest in liquidity, smart beta and customized solutions is leading to an increased interest in ETFs among institutional investors.
“I think for ETFs, there’s an attractive component in the instant liquidity, as opposed to indexed mutual funds,” Mr. Sykes said. “And to the extent that there’s a move (among asset owners) to tactical asset allocations, ETFs can be easily incorporated into that.”
Mr. Sykes added the move to use ETFs in lieu of traditional futures is another component of growth.
Filing with the SEC to launch proprietary funds is not the only avenue to provide ETFs to institutional clients. A couple of companies have gone the acquisitions route.
In December, New York Life Investment Management agreed to purchase liquid alternative ETF developer IndexIQ for an undisclosed sum.
After first filing an application for actively managed ETFs in September 2010, then making various amendments to the application over the years, Denver-based Janus Capital Group in 2014 agreed to acquire VelocityShares, a boutique shop that specializes in institutionally focused ETFs.
Also, Virtus Investment Partners Inc. in January agreed to acquire a majority interest in ETF Issuer Solutions, a New York-based company that lists, operates and distributes ETFs. The transaction will provide Virtus with both active and passive ETFs.
NYLIM CEO Yie-Hsin Hung said that building up its ETF capabilities organically would have been “a multiyear exercise.”
‘HERE TO STAY”
“ETFs are here to stay,” said Ms. Hung. “We’ve been seeing our clients very focused on portfolio construction and asset allocation. And in that context, ETFs are very important, since they provide transparency and liquidity.”
Adam Patti, CEO and founder of IndexIQ, agreed. “ETFs are a great way to gain access to specific exposures,” he said. “We’re seeing a lot of that as institutions become more comfortable with ETFs.”
Mr. Patti added that NYLIM’s acquiring IndexIQ not only gave NYLIM the ability to offer its institutional clients ETFs, but it also helped IndexIQ get on the radar of many institutional investors and consultants.
“Getting into the market is a long process, and gaining the reputation and track record is also very difficult. We’ve seen an uptick in the institutional market,” he said.
Added Ms. Hung: “When ETFs were new, institutions were using them for liquidity exposures. Now, they’re more comfortable adding them as part of the portfolio. We see ETFs and active strategies as very complementary to one another.”
James Comtois is a reporter at sister publication Pensions & Investments.