ETFs at the tipping point
By Bryon Lake, Head of International ETFs at J.P. Morgan Asset Management
The mass market adoption of exchange traded funds (ETFs) is approaching a tipping point. ETFs already account for 29% of investment portfolios globally, up from 22% in 2016, but in two to three years this figure is set to increase to 39%, according to a new survey by J.P. Morgan Asset Management of 240 institutional investors with over $14 trillion in assets under management.
Investor allocations to ETFs and motivations for using them vary, particularly by region, but a number of global trends are clear. Notably, areas of early adoption continue to dominate allocations, and their success is spurring further strong ETF growth across asset classes, regions and styles.
Fixed income ETFs on the rise
Equities have been the entry point to ETFs for many investors, so it’s perhaps unsurprising that equity ETFs remain the largest allocation in client portfolios at 16% of total assets, or 53% of the ETF allocation. These numbers are expected to rise to 21% and 54%, respectively.
Professional investors also want to increasingly bring the same liquidity, transparency and diversification provided by equity ETFs to their fixed income allocations—benefits that are particularly attractive in bond markets, where pricing can be opaque and liquidity fragmented. The survey suggests that fixed income ETF allocations could grow by a quarter over the next two to three years to reach 10% of total client allocations. It’s worth noting there was consensus among professional buyers that alternative ETFs and multi-asset ETFs would also attract a lot more capital over the coming years.
When it comes to overall ETF allocations, US survey respondents continue to lead the way, with more than half of US client assets (54%) expected to be invested in ETFs in the next two to three years—a 32% increase. However, while overall allocations are lower, ETF use in the Asia Pacific and EMEA regions is expected to grow even faster than in the US, at 43% and 36%, respectively, over the same time period.
Time to get active
Passive strategies remain by far the most popular with global investors, commanding a 63% share of ETF assets compared to 28% for actively managed strategies. However, the options for investors seeking to combine the benefits of active management with the convenience and liquidity of ETFs are expanding rapidly. Almost half of the professional investors surveyed believe their clients will be interested in active equity ETFs in the next two to three years. In the Asia Pacific region, 40% of respondents are already looking to invest in active ETFs.
Thematic ETFs, which aim to benefit from long-term macroeconomic and structural trends, are another potential growth area, with 38% of respondents expecting client interest in the next few years. Investors note the ease of obtaining niche market exposure and the potential return from long-term structural trends as two of the main benefits. Expected interest in ETFs with an environmental, social and governance (ESG) focus was cited by 35% of global respondents.
Focus on liquidity
Fees and costs are the clear number one advantage of ETF investing, cited by 83% of the survey’s respondents. The focus on costs is particularly evident in the US, where 90% of survey respondents cited lower costs as an advantage of ETF investing and 80% cited cost control as objective. As well as cost, ease of trading, diversification and particularly liquidity were also given as key ETF advantages by roughly half of the respondents globally.
Liquidity stands out as a key advantage and risk for ETF investors. Perhaps because respondents see enhanced levels of liquidity as a key reason to use ETFs, they are also highly sensitive to any threats to ETF liquidity, with two thirds of professional buyers citing liquidity issues under a major bear market as a big risk of investing in ETFs.
Some investors may have worries that recent changes to market liquidity, such as the greater use of automated trading systems and the rise of high-frequency trading, have increased liquidity risks during periods of market stress. Liquidity concerns may also explain why respondents say that they are focused most on market volume and bid-ask spreads when trading ETFs.
Taking the long view
Also striking are the findings regarding the strategic use of ETFs. Nearly 50% of those surveyed said they use ETFs for long-term investing compared to 35% who said they use them for short-term investing. Similarly, 59% of investors cited capital growth as a preferred strategy for using ETFs while only 19% cited hedging. These findings challenge the commonly held perception that ETF investors tend to be intrinsically short-term in nature.
While ETF investors may be proving more long-term-oriented than originally thought, the strong growth in ETF assets and the continued rise in institutional allocations clearly illustrates that ETFs will be around for a very long time.