Ease of use top reason for choosing ETFs

Pension schemes use ETFs for a variety of reasons. Some schemes like the inherent characteristics of ETFs: low cost, liquidity and instant market access. Others use ETFs to gain exposure to markets that would otherwise have been difficult or expensive to access. We are also seeing an increase in the number of investors using ETFs for strategic long-term holdings.

Traditionally pension schemes have used ETFs to access equity markets. Today, according to a Greenwich Associates report commissioned by BlackRock, 94 per cent of schemes that have allocated to ETFs use an equity ETF.

In contrast, 60 per cent of pension schemes using an ETF invest in fixed income, and 40 per cent in other asset categories.

Looking to the future, however, ETF growth will be driven less by the continued advance of equity ETFs and more by the spread into new asset classes and applications.

Pension scheme allocation through an ETF is likely to increase as the result of five factors:

• Increased demand for fixed income ETFs: While liquidity challenges in fixed income markets have become more prominent in the last year, bond ETF liquidity is increasing. This could further spur demand.
• Development of new investment exposures: Interest in smart beta (non-market-cap weighted) ETFs is increasing. More than 20 per cent of institutional users are now investing in these products. This trend could accelerate as the ETF sector innovates further.
• Strategic uses are on the up: Nearly half of pension scheme ETF users are holding them for more than two years. With the European ETF market on a similar trajectory to the US, we expect an increasing number of schemes to expand their use of ETFs for longer-term strategic functions as they become more familiar with the funds.
• ETFs are replacing derivatives: Investors are increasingly evaluating ETFs along with derivatives to determine the best tool to gain market exposure. This year, 41 per cent of institutional investors plan to replace an equity futures position with an ETF; nearly one in five (19 per cent) plan to do so with fixed income positions. 
• Growing popularity of multi-asset funds: a quarter of pension plans in the UK now invest in multi-asset funds. ETFs are widely used in multi-asset strategies and we are likely to see other strategies coming to market that use the characteristics of ETFs to an even greater extent.

Ashley Fagan is head of UK institutional at BlackRock’s exchange traded funds arm iShares