4 ways to go “pro” with ETFs

Exchange-traded funds are popular with many big institutional investors. A look into why can give every investor something to think about.

You can learn a lot from watching the pros. Focusing on a professional golfer’s swing or an expert auto mechanic’s online oil-change video can improve your fundamentals and provide some best practices for your own activities. The same holds true for building an investment plan.

While there’s no shortage of noise out there, it can be worth looking at what the “long-term money” is doing: the pension funds, portfolio managers, consultants and others who are collectively responsible for the financial futures of thousands of clients and millions of workers, retirees, individual investors.

One unmistakable trend among institutions is the rapid growth of exchange-traded funds (ETFs). These investors continue to discover innovative ways to use ETFs, as the Greenwich ETF adoption research study shows. Like the rest of us, they are seeking outcomes such as growth, income, reducing risk, and liquidity, amid an uncertain geopolitical, market and economic landscape.

About the survey

The Greenwich ETF adoption research study was conducted from October 2016 to January 2017, by Greenwich Associates, an independent research company. The study surveyed 187 institutional investors, including institutional funds, asset managers, insurance companies, investment consultants and RIAs, with a total $6.7 trillion in assets. Over a third have assets under management (AUM) of more than $5 billion, about one-quarter manage more than $20 billion, and 10% have AUM in excess of $100 billion.

So what can we learn from the pros? One difference between retail and institutional investors is that the latter are taking a more expansive approach to ETFs. They’re embracing a wider universe of choices to meet a broader range of portfolio objectives.

Here are four trends you might want to consider:

Sophisticated investors are being “active with their passive.”

Big institutional investors know that asset allocation—how you divide your portfolio across different stocks, bonds and other investments—is the biggest determinant of success. And they’re capitalizing on the versatility of ETFs to help do just that, by building core positions, making tactical adjustments, diversifying internationally, seeking to manage risk and putting cash to work.

ETFs can help ease cost pressures.

Price is front and center for large investors, many of whom have a fiduciary duty to act in their clients’ best interests. At the same time, uncertain market prospects mean paying close attention to cost to meet return targets is important. According to the survey, 7 in 10 institutional investors are replacing “low-conviction active” mutual funds—so-called index huggers—with low-cost ETFs.

They’re taking advantage of ETF innovation.

Next-generation indexing has taken the ETF beyond traditional market-cap-weighted exposures, to strategies that were once the province of higher-cost active mutual funds. For example, more than 40% of the surveyed asset managers who use ETFs invest in low-cost smart beta ETFs, which seek to capture factors such as minimum volatility, dividends, quality and value. These portfolio tilts, whether singly or combined, can help enhance growth potential or reduce risk.

Bond ETFs are an essential part of their investment toolkits.

Of institutions that use ETFs, 71% surveyed invest in bond ETFs, and nearly half expect to increase their investments in the coming year. For these professionals, liquid bond ETFs are a convenient, diversified way to hedge against rising rates and seek higher yields, at lower cost than active mutual funds.

A “best practice” needs to be best for you, of course. But if there’s one tip to take from sophisticated, long-term investors, it’s to look at your portfolio through the lens of the goals you’re aiming to achieve, and then finding the right investments at the lowest cost. That may be an ETF.

Martin Small is the Head of U.S. iShares and a regular contributor to The Blog.

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