ETFs less popular with institutional investors

Latest European Institutional Asset Management Survey (EIAMS) reveals allocation to fixed income is up while use of ETFs is down.

While retail investors continue to invest in Exchange Traded Funds (ETFs) as a transparent and low-cost investment vehicle, the latest European Institutional Asset Management Survey (EIAMS) indicates that institutional investors prefer alternative cost-saving solutions such as segregated passive accounts or derivatives. According to the survey,  the popularity of ETFs has slipped noticeably with 28% of respondents used ETFs in 2010, down from 34% in 2009. The annual survey, whose main focus is on European pension funds and insurance companies, points to an ongoing increase in fixed income allocations in European institutional portfolios, while equities were pared back somewhat and real estate only maintained its position in investor portfolios between 2009 and 2010.

In the aftermath of the market crash of autumn 2008, alongside growing risk aversion in the insurance sector, and faced with maturing pension funds, the closure of defined benefit pension schemes in some countries, mark-to-market regulations and historically low current interest rates, European institutional investors continue to place great emphasis on the management of liabilities. Used by more than half of all EIAMS 2011 respondents, liability-driven investment strategies remain the most popular way of matching liabilities, particularly for larger investors.

With the relative recovery in investment markets, the shape of Europe’s institutional portfolios is becoming clearer. “Overall, the 2011 survey results give a mixed picture of investor confidence,” says Michael Gartmann, Managing Director and Head of Institutional Business Germany, Invesco CE “Fixed income continues to gaini more ground, last year’s freefall in equities appears to have been halted with just a small decline, and the sharp reduction in cash suggests that investors have spotted more attractive opportunities.”

Overall, allocations to fixed income rose to 58% in 2010, up from 51% the previous year and the highest level since 2006. Equities fell back to 27% of assets in 2010 from 29% in 2009, still well above the crisis-year level of 25% in 2008. Alternatives held their own at about 12% of portfolios, with real estate retaining its average 7% share of portfolios. Cash holdings shrank to 2%, down from 5% in 2009 and 10% the year before as investors returned to the markets.

The EIAMS signals remain green for fixed income looking forward. Across Europe, the average duration of investors’ liabilities increased to 16.37 years from 15.69 years in 2009, reversing the downward trend identified in previous surveys. In addition, 22% of survey respondents said they were planning to increase their allocation to fixed income, compared to 16% aiming to reduce their exposure to the asset class. According to Invesco’s Gartmann, the stronger shift towards fixed-income instruments may reflect a cautious view on the global economic recovery and pressure on the insurance sector from the Solvency II requirements, among others.

Following a year in which the peripheral debt crisis dominated the headlines in Europe, corporate bonds appear to be the big winner of investors’ growing interest in fixed income, at the expense of government debt. While more than one-fifth of investors are aiming to increase their fixed income component, 31% are reducing their government bond holdings, with 30% opting for corporate bonds. The survey also notes an increasing focus on emerging market debt due to concerns over inflation, low government bond yields and the growing perception that developed economies sovereign debt can no longer be viewed as a risk-free asset class.

But despite the growing dominance of fixed income, “the real assets story is far from over,” Gartmann says: 19% of investors are poised to raise their equity stakes and 26% their real estate allocations, with only 15% and 7%, respectively, planning to reduce these portfolio components. Only the large investors (over €5bn in assets), composed mainly of insurance companies in the sample, have reduced their equity holdings while significantly increasing their fixed income holdings.

Already slim in this year’s survey, average cash allocations of just 2% could drop to negligible levels during the course of this year as 21% of respondents plan to reduce their strategic cash allocation in 2011, while only 5% plan to increase it. The previous year’s recovery in alternative investments also continued in 2010, with institutional investors again increasing their allocation to the sector in the hope of adding value to their portfolios. Real estate continues to dominate alternatives, accounting for two-thirds of total allocation. Private equity and hedge funds, however, are finding it difficult to reassert themselves. Hedge fund allocations more than halved compared to 2009, dropping to the lowest level in three years. Meanwhile, 15% and 34% respectively of investors plan to increase allocations to commodities and ‘other alternatives’, as against 3% and 9% indicating a decrease.

An investment tool whose popularity has slipped noticeably is Exchange Traded Funds (ETFs).  28% of respondents used ETFs in 2010, down from 34% in 2009. While retail investors continue to flock to this asset class as a transparent and low-cost investment vehicle, the EIAMS survey indicates that institutional investors prefer alternative cost-saving solutions such as segregated passive accounts or derivatives.

Taking into account that institutional investors externalize the management of 64% of their reserves, a level remained stable since the beginning of the crisis, one can conclude that there is still room for more delegations, namely of equity products.

For the first time since 2006, the use of external investment consultants among EIAMS respondents fell below the 50% mark in 2010, to just 49% from 52% in 2009. Medium investors remain the largest users of consultants, with both the larger and smaller investors showing steady declines in usage over the last three years. “Asset allocation is now the top reason for using consultants, followed by selecting investment manager and risk management advice. Investment performance measurement and alternative investment advice show an increase again, indicating that the overall fall in usage may have been a short-term reflection of the recession” Gartmann says.

Meanwhile, the trend towards the use of external managers continues unabated, with 67% of respondents now managing externally, up from 64% in 2009. However, investors seem to be more willing to play the field, with the number of investors terminating their relationships with external managers rising to 53% from 40% in 2009. “Poor performance as ever is usually the trigger, but many investors seem to be venturing into new territory – and will sack those managers who cannot chart the way,” Gartmann says. He believes this may reflect a more confident attitude towards investing: “Having weathered the first storms of the recent financial crisis by sticking to the tried and tested, investors now feel they are in a position to flex their muscles.”

The EIAMS, which Invesco has sponsored since the launch of this survey series 11 years ago, is one of the most widely used reference documents for trends in European institutional investment, providing year-by-year comparisons of asset allocation strategies across Europe and valuable insights into likely changes in asset allocation over coming years. The EIAMS 2011, conducted for the fourth time in partnership with Investment & Pensions Europe (IPE), covered 148 investors from 25 countries with combined assets under management of €1,194 billion. The EIAMS 2011 has been supported by the Association Française de la Gestion Financière (AFG) and NYSE Euronext.