ETFs are not only for the retail investor looking to make investments on the cheap; product providers and researchers report institutions are increasingly driving ETF inflows by adding them to portfolios.

As a result there's an opportunity for ETF providers to position their products to institutions considering a move, says Eric R. Ervin, CEO and co-founder of Reality Shares, noting that capturing even a single institutional investor can bring millions to a fund almost instantaneously.

In its January study of the ETF market, PricewaterhouseCoopers estimated that the market would grow 6% a year, and nearly doubling by 2020, largely driven by institutional investors.

"This year alone, nearly $32 billion has flowed into fixed income funds, $18 billion into equities, and looking at that, considering the market's up, and there wasn't a real move out of stocks, so why?" Ervin asks.

"What you'll find is that a lot of that came from institutions, with bond ETFs as the vehicle of choice, instead of allocating more to money managers buying bonds."

"ETFs are a nice vehicle that capture that entire portfolio, and there's more and more liquidity in the ETF space so it's easier to do now for institutions."

In February, the U.S. ETP market saw net inflows of $34.4 billion, according to research firm ETFGI.

Ervin says that increasing investor shift to ETFs has made them a more palatable option to institutional investors. The benefits to be gained by any ETF provider are immediate, he adds. His firm has made it a priority to start meeting with heads at institutional investment firms, he says, and at least begin the discussion.

"It's great for us, which is why we have started talking to institutional investors. Other ETFs have gone from $10 million to $100 million in a day because an institution took a position."


Not every institution is receptive to the idea of taking a position in an ETF, Ervin adds.

"The educational institutions and endowments seem to be a little more cutting edge," he says. "You'd figure the typical public pension might be slower to make a move than an academic institution. Harvard and Yale were the first to really allocate to hedge funds versus pensions."

The Yale model is a good example of a cutting edge institutional investor, but one that has been hard for most university endowments to replicate, says Larry Petrone, research director at kasina. And for one simple reason, he explains: they are not Yale.

"A lot of those endowments tried to replicate the Yale model, but then found that they couldn't do it," he says. "The problem was that they didn't have access to the best managers, and they weren't big enough to directly invest in real assets."

Which is why these institutions have turned to ETFs and passive investing in particular, he says. "Institutions are investing in ETFs pretty heavily," he says. "Whether it is in enhanced indices, factor beta or the Russell 3000, institutions are number one."

The institutional investor has begun investing in ETFs for the same reason that many retail investors are now flocking to them: full exposure with minimal costs.

"It gets back to the Vanguard model," Petrone says. "How can I do it cheaply? Then it becomes more of an asset allocation game."

Petrone adds that institutions haven't dropped actively managed investments, and will continue to put positions with private equity and hedge funds, where there is demonstrated performance.

And among many institutional investors, there is a preference to be invested in real assets, he says, particularly for the public infrastructure market.

"I don't think institutional investors will ever be 100% ETFs. They will always look for an advantage, given their size. But if it's not the right exposure, why bother paying high fees?"


Increasingly among institutions, the cost of investing in a passive ETF versus an actively managed fund or hedge fund is a strongly persuasive factor, says Lucas Turton, managing partner and chief investment officer at Windham Capital Management.

Turton spoke of his recent experience meeting with institutional investors in Australia and some in the U.S., that were more conservative in their approach and preferred futures.

"What we've done - and note that I don't sell ETFs; we're simply promoting the least costly method to implement investing strategies - is pull up a Bloomberg screen, and show the difference between trading futures 'X' and ETF 'Y.' After a total cost analysis, and considering the rolling fees and management collateral that you associate with replicating futures, nine times out of ten, the ETF is victorious."

"Looking at alternatives," he adds, "if cost is what matters to you and liquidity is important, ETFs are pretty good tools."

Again, the increasing use of ETFs in the retail market is making it easier for institutions to talk about the ETF positions that they are taking, Turton says.

"I think they got more comfrable doing it four or five years ago, and admitting it about two years ago," he says. "There was a period you didn't know unless you dug."

"Now people are more comfortable with ETFs, given their transparency, and your ability to trade them. They've become very useful tools to a lot of investors, not just financial advisors."

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