Dynamic access: Pension funds and ETFs

In association with Professional Pensions, ETFM asks a panel of experts to discuss the use of ETFs among pension funds and institutional investors

Emma Dunkley: The European ETF market has soared in recent years with assets under management hitting $284bn at the end of 2010. This panel will focus on how pension funds and institutional investors are currently using ETFs, the benefits and how they compare to traditional index funds. How can pension funds use ETFs and what are the benefits on offer?
 
Manooj Mistry: ETFs can be used in a variety of ways. They provide a low cost beta access tool that is liquid and highly efficient in terms of how it tracks the underlying index. They are flexible enough for both long term strategic and short term tactical asset allocation. ETFs offer pension funds access not only to traditional equity markets but all different kinds of asset classes – fixed income, commodities, even hedge funds. All of these allow pension funds to be more dynamic in the way they run their strategies.

Emma Dunkley: Pension funds are arguably more familiar with using traditional index trackers. How do ETFs compare?

Nizam Hamid: Pension funds have used a lot of index tracking funds over the past 10 to 20 years, but a lot of work has to be done either to maintain or change your asset allocation, so it is not a dynamic process. Adding an ETF to your portfolio allows access to different markets but also short term tactical moves. The costs of trading compare very favourably with an index fund, where TERs are often low but there are high costs as you move in and out. Index funds can be good vehicles for core holdings, but a lot of investors are using ETFs where index funds can be expensive.

Emma Dunkley: Would you also say ETFs offer the opportunity for pension funds to tap more diverse asset classes, compared to the range of index trackers available?

Matt Holden: One of the beauties of the ETF wrapper is that it is a standardised settlement process. If a pension fund were to go to, for instance, the futures market, the derivatives market, the bond market, it may not have the sophistication on the settlement side of things to gain access. ETFs also allow you to line up the movement of your funds, so they are an important instrument for transition managers as well.

Manooj Mistry: The technology that exists to construct ETFs affords much more varied access. As the ETF market grows in Europe investors are actually demanding more niche access. The fact that providers launch so many different products, such as those in Vietnam or in hedge funds, shows that there is demand out there.

Emma Dunkley: Bearing in mind that pension funds are long term investors is the liquidity and intraday trading of ETFs really necessary?

Matt Holden: An ETF brings a number of liquidity pools into one stream. The advantage of being able to trade intraday is that whoever is selling out of an asset may be able to offer a discount at the point you are purchasing an ETF. Extra liquidity is key in asset classes where there may traditionally be a wide spread or a costly entry because of taxation or fees. You get ETFs where the spread is significantly smaller than in the underlying asset itself, a key example of which would be in Brazilian equities – buying Brazilian stocks would incur taxes of say 2%, but the ETF spread may be much smaller than that.

Nizam Hamid: Intraday liquidity is one of those things you never know you need until you really do need it. A shock to the system, such as the recent events in the Middle East, makes you understand why you need that access.

Emma Dunkley: Are there any geographical areas where pension funds are more enthusiastic or longer established users of ETFs?

Nizam Hamid: Typically, clients that were the earliest to diversify their portfolios use ETFs the most. A lot of that is in the Netherlands and in Scandinavia, where there has been long term use of US based ETFs simply because that is where liquidity has been. These countries are now beginning to use and trade the equivalent European products.

Manooj Mistry: There is also a greater adoption of ETFs in countries where the pension fund manager is making that decision themselves, rather than being reliant on consultants. That is critical.

Emma Dunkley: What are the issues or hindrances preventing a greater uptake of ETFs by UK pension funds? The ETF industry in Europe is still perhaps relatively young, and there is the issue of using a consultancy based model.

Matt Holden: We are lobbying for Mifid to accept ETFs into its universe of assets, which will create greater transparency over trading. This is key. A lot of our marketing is focused on convincing people that there is good liquidity because we can access the underlying assets in the fund.