Expecting to Grow
A study shows more than 600 insurance companies were using exchange-traded funds in their investment portfolios in 2017.
- Meg Green
- May 2019
Exchange-traded funds have grown to over $5 trillion in assets under management since the first U.S. product launched in 1993.
Global investors recognize that ETFs offer cost-efficient investment exposures along with transparency and liquidity. In the webinar “What Insurers Should Know About Four Trends Transforming Asset Management,” a panel of experts from iShares and Greenwich Associates discussed four trends that will fuel future ETF growth and how these might transform insurance general accounting portfolios.
Taking part in the webinar were Joshua Penzner, managing director, head of iShares' Fixed Income and Insurance and Andrew McCollum, managing director, Investment Management Greenwich Associates.
Following is an excerpt from the webinar.
Could you give us an overview of those four trends that are transforming asset management?
Penzner: I think what's really exciting about the ETF industry, is it's not simply what it means for insurance companies. It's what it's done to investing overall, across institutions, asset owners, asset managers in the wealth space, too.
When I look back, it was only in 2000 that there was $100 billion in ETFs globally. There's now over $5 trillion. That's a pretty powerful generational-defining investment trend. Why is that? Why do we think it could get even up to $12 trillion within the next four to five years?
Really, there are four themes that are defining investing with regard to ETFs and accelerating. The first is that all investment decisions are active. This idea of active versus passive is old news. Any time an investor decides the vehicle, the asset, the asset class, the security that they want to buy or not buy is an active decision.
The second is that the cost of investing is declining. As we think about how do investors build portfolios, they're trying to find the most efficient way to express that view. ETFs are an important part of this trend.
By the way, ETFs can often get a bad rap in terms of the race to zero in fees. That's not what it's about. Fees are declining across the board whether it's for active, index or factor investing. Again, we think that's going to be an important push to ETF adoption.
The third is that the bond ecosystem is changing and evolving. The way bonds are traded ... over-the-counter, voice-to-voice, bond-by-bond is really declining, certainly transforming. It's not simply a matter of brokers, dealers having balance sheets of individual bonds.
It's actually also about the rise of electronic trading platforms, the rise of different ways to trade bond risk through things like an ETF. Finally, the way financial advice is given is being transformed, as well. We heard, for a number of years, about the fiduciary role. In Europe, there's this concept of MiFID II [a revised version of the Markets in Financial Instruments Directive].
Really, the idea is that commission-based advisory investment advice is shifting to fee-based advisory, which makes the investment advice really more about, “How am I building portfolios? Am I building them efficiently? Am I building them at scale?”
ETFs are a very important piece of that. Again, this idea of investing is an active decision. That costs are declining, that the bond market is changing, and that the way advice is given is evolving, is really pushing ETF adoption, not just for insurance companies but across the investing landscape.
What do these macro trends mean for institutional investors? Can you tell us about the Greenwich study?
McCollum: These changes are effectively changing the way that institutions are constructing their portfolios. We're seeing shifts in asset allocations. We're seeing changes in the products that are being used. Certainly, we're talking about ETFs, we're seeing changes in the vehicles that institutions are using.
In an effort to track some of these trends and get a better understanding of them, Greenwich conducted a broad-scale global study. We conducted interviews with over 450 institutional investors. They were pension funds, they were corporate and public pensions, they were endowments, foundations in Europe.
This was a global study. We spoke with some discretionary wealth advisers. Here in the U.S., we spoke with IRAs and with quite a few insurance providers as well. These were very large institutions. About 40% of them had more than $10 billion in total assets under management.
The goal of all of these interviews was to understand the trends in ETF use and how they were thinking about using ETFs in their portfolios. That's the study that we conducted.
What are the biggest drivers of growth for ETFs in the institutional arena?
McCollum: Building on some of the things that Josh was talking about, in our research, there were two main drivers of growth in ETF utilization this year. The first driver, I would describe as environmental turbulence. If you think back to 2018, there were a lot of macro issues that were impacting investment decisions and investment thinking.
We had three Fed rate increases. That caused a lot of uncertainty about how quickly the Fed would tighten rates, which lead to some thinking around, “Is this the end of the business cycle?” We're arguably in the longest bull market in the history of the markets or, at least, recently.
People are a little concerned about are we coming to the end, especially in the fourth quarter in December when there was a lot of volatility. There were some volatility spikes particularly in December of last year. Then there were some other macro issues related to trade—the China-U.S. trade issues, NAFTA.
Then, of course, if you look across the pond, there were concerns about what was happening in the EU with fragmentation and Brexit. All of those issues caused investors to think closely about risk management. As they were readjusting their portfolios to address the risks that they saw, they were oftentimes applying ETFs to address those issues.
That was the first driver of ETF adoption this year, the market turbulence, if you will.
The second big driver was, what I call the index revolution. This is not new news. It's been going on for almost a decade now. We've seen a lot of institutional investors shifting from active products that are underperforming, toward passive or index products. That's not new news.
What was happening this year, however, was that because it was a volatile environment, an environment where active investing is supposed to outperform benchmarks, there was some disappointment in the performance of those products.
In our research, what we noticed was that the vast majority, I believe it was 78% of investors, consider ETFs to be the preferred index wrapper. As products move from active to indexing, it was a big boon for ETF growth this past year. Those were the two big drivers of growth that we found in our research.
Penzner: What's particularly interesting about both the study itself and the results that you described is one, these are large institutions that are describing their focus on and interest in use of ETFs. In the insurance space, the first movers, interestingly enough, had been more small and midsize insurance.
What this tells me and the way I hear you talk about the result is that the room for growth is pretty impressive. If we're hearing this now from the larger institutions—asset managers, asset owners, pensions, foundations, endowment, insurance companies—the momentum is shifting. The buyer is shifting, evolving or growing.
When you talk about these two trends, we talk about global macro issues every year, as we're talking about it in the beginning, this is a defining investment trend. Those are not slowing down.
McCollum: If you compare the allocations of insurers to some of the other channels that we interviewed as part of this research, you will see that there's just a ton of opportunity from a growth standpoint for insurers. They are still well below the allocations that you see in pension funds, or certainly, asset managers.
Looking back over the last three to five years, have you seen the adoption change?
McCollum: This is actually the ninth time that Greenwich has conducted this study. We have quite a bit of trend, and it's been really interesting to watch the adoption of ETFs in the institutional market.
When we started nine years ago, and we asked institutions whether or how they were using ETFs in their portfolio, they would typically give us what I would describe as a tactical use case. They would talk about holding ETFs maybe to get short-term exposure, maybe during a manager transition.
The holding period was typically quite short, but as institutions—and we've really seen this over the past three to five years—have started to get experienced with ETFs in their portfolios, they come to realize that they're actually quite versatile tools and can be used for more than these short-term tactical portfolio functions.
They can be used for much more strategic functions in their portfolios, maybe to get international exposure, even as a core holding in your equity or your fixed income portfolios. As a result, we see the holding periods expanding, we see the use and the allocations increasing.
That's really where a lot of the growth has come, not only new users coming online as they see their peers doing it but also current users broadening their use and using ETFs for a much broader set of portfolio functions.
Penzner: It's also [that] the reasons for usage, and the reasons for not using, are declining, too.
If you were to look years ago, it's “I don't have them in guidelines,” or “I haven't gotten them approved by my investment committee,” or “They haven't gone through the risk process.” Even those numbers have come down.
McCollum: You don't hear that much anymore. When we started maybe 30%, 40% of people would say things like this. These days it's few and far between.
Penzner: It's interesting, and you said that holding period of being greater than a year is a pretty dramatic statement from years past where people say, “I would never consider an index product or an EFT product for my portfolio, and I certainly wouldn't earn it for a long time.”
McCollum: Very different now.
Turning to the insurance industry, what are the biggest drivers of growth in that space?
Penzner: This is what gets me real excited, the opportunity, and Andrew talked about it, the runway for growth. It's great for the industry overall, the insurance industry, the opportunity is significant. If you looked at the data, we're still waiting for the 2018 year-end information to come in, but the three-year compound annual growth rate for ETF and option insureds was 25%.
That's an incredible number. When you break it apart, 16% in equity, which is a pretty impressive adoption rate and, frankly, growth rate for any product in the asset management industry. It was dwarfed by the fixed income adoption rate, which was roughly 72%. Again, this is 2017 year-end data.
We have no reason to suspect that adoption is declining for sure in 2018. I think that we can hope for 72% growth in fixed income over the long term. That would be fantastic. I think, though, we have to acknowledge that things may slow a little bit. That said, you often get a lot of skepticism. Are insurers really embracing ETFs? Let's set aside the growth rates. Let's look at the sheer numbers of insurance companies using it. Over 600 insurance companies, as reported at the end of 2017 were using ETFs.
That's a pretty amazing number, particularly for an industry that tends to be slower-moving and more conservative and thoughtful and has a lot of constituents and stakeholders that they have to make sure are on board before they adopt a new product for their portfolio-management process. I think that the story of ETF growth for insurance companies is still to be written.
We're still early in that. Why are they using it? Andrew alluded to this. It's not about the ticker. It's not about the actual ETF. It's, what role can it play in the portfolio? What's the use case? Andrew talked about tactical asset allocation.
That's such an important use case for insurance companies to be able to move into and out of a market on opportunity whether it's after a market shock or a market surprise like Brexit or a presidential election. Whether it's a way to get exposure over time because you think that we want to build up a core allocation and more niche asset class.
Then there's this concept of liquidity, which is to say that I get so much cash as an insurance company. Sometimes it comes predictably. Sometimes it's unpredictable.
Usually the outflows are unpredictable. Having to navigate that cash and that liquidity, ETFs can play a role for that. Finally, I think about, from a strategic perspective.
This is where the industry has so much opportunity. Looking ahead is that the ability to use an ETF to build a core position, whether it's equity or fixed income, to be operationally efficient, is pretty unique.
I think we'll start to see more and more of that. You're starting to see that in the results from the survey.
Again, this idea of thinking about it. It's not about the ticker. It's not about the product. It's about the use case that is really resonating with insurance.