Trends for ETF Usage in 2013

January 29, 2013 (PLANSPONSOR.com) - Active manager and adviser exchange-traded fund (ETF) investment portfolios are expected to grow in 2013.

Active asset managers will likely continue to use ETFs for asset allocation, in an effort to achieve alpha in balanced funds, asset allocation funds, defined contribution (DC) funds and annuities, sources at BlackRock predicted during the iShares Institutional Outlook 2013 media briefing.

State Street Global Advisors (SSgA) reported that ETFs had positive cash flows of $182.6 billion in 2012, marking a record high for the industry (see “ETFs Have Record Year in 2012”). Daniel Gamba, managing director for BlackRock’s iShares Americas Institutional Business, said this year also looks to be an outstanding year for ETFs. “2012 marked a record year for inflows into ETFs for the industry and iShares, as investors continue to use ETFs for the diversification and exposures they seek in their portfolios,” he said. “In the coming year, investors are likely to face continued market volatility while they search for yield in a low-rate environment. Given these dynamics, we see the trend of institutional investors using ETFs, particularly as part of the core of their portfolios, continuing in 2013.”

For 2013, BlackRock sources also predict growth opportunities for advisers who provide expertise about ETF portfolio construction and trading to other advisers seeking outsourced model portfolios.

Gamba foresees that in 2013, institutional investors will seek more liquidity—specifically, liquidity sources that provide market exposure to minimize cash drag. “So they will use ETFs to replace a part of their portfolios,” he explained.

Institutional clients are increasingly implementing overlays that include ETFs in order to mirror the risk/return profile of a portion or the entirety of their policy portfolio, BlackRock sources said. According to Greenwich Associates, the percentage of institutions implementing these strategies with ETFs increased from 3% in 2010 to 31% in 2012.

Also in 2013, BlackRock predicts that ongoing forces within the capital markets—like increased volatility and decreased liquidity in the underlying bond market—may drive more institutions to use fixed-income ETFs to access and manage fixed-income exposures more efficiently. This year, BlackRock expects institutions will continue to use developed market fixed-income ETFs for passive core allocation, tactical strategies, transitions and risk management.

Despite the increased usage of ETFs, sources acknowledged they are still in the early stages. ETFs still have not penetrated the 401(k) market, for instance, said Sue Thompson, managing director of the Institutional Asset Management/RIA Channel. According to the 2011 PLANSPONSOR DC Survey, only 1% of plan sponsors say they include ETFs in their fund lineups.

Operationally, ETFs as 401(k) investment options can be challenging because ETFs are traded like securities, and 401(k) platforms are oriented toward mutual funds, which are not traded intraday and do not have commissions (see “ETFs: Passive Interest”).

Fortunately, Thompson said, recordkeepers are working to fix the “plumbing issues” with using ETFs in 401(k) plans.

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