Head of institutional ETF distribution at Franklin Templeton explains what’s caused a shift in attitude for ETFs and what they’re being used for
Exchange-traded funds – or ETFs - have long been viewed as a retail investment product, but over the last several years, institutional investors have increasingly embraced these versatile investment vehicles. As a result, ETFs are going far beyond their original purpose as low-cost index-tracking products.
Bobby Eng is the vice-president and head of platform and institutional ETF distribution at Franklin Templeton. He explains why ETFs are not just for retail investors anymore, noting that institutional investors are starting to understand the benefits of using ETFs as part of their portfolio management and asset allocation strategies. He also highlights why institutional investors tend to lean more towards passive ETFs.
When ETFs were first introduced in the early 1990s, they were primarily aimed at institutional users, offering efficient market exposure with a single trade. However, their ease of use and cost-effectiveness soon attracted retail investors, shifting their image, Eng explains. “ETFs really came to the marketplace for the institutional investor. They tend to be more retail oriented just because of the popularity and the ease of use and the benefits, but institutional investors use them much more now, especially asset managers,” he says, pointing to the benefits of broad asset allocation.
As Eng asserts, ETFs shouldn’t be viewed as a competing product, but rather as an investment tool that can help institutional investors for portfolio management. “If you position ETFs differently, and you can position them in a way that can help run the portfolio, then it's much more welcome. Over the past 5 to 10 years, institutional investors have been using them in that way more and more.”
This shift in mindset has been particularly evident in how institutions deploy ETFs for market exposure. This includes gaining access to developed and emerging markets, fixed-income instruments, or even country-specific investments. Notably, India has emerged as a popular overweight target for emerging market portfolios. Franklin Templeton’s India and broader Emerging Market ETFs stand out with competitive fees as low as 19 basis points, significantly undercutting larger competitors, says Eng.
“In particular, we’ve seen our passive single country ETFs being used within Emerging Markets mandates to provide low cost, liquid, transparent and tradable exposure to countries such as India, Brazil, Taiwan and South Korea. But what we're seeing more and more is exposure for tactical country trades,” he says.
Eng notes that most institutional investors tend to use passive ETFs for low-cost beta exposure in a variety of different strategies including cash equitization, transition management, rebalancing, tactical adjustments, and liquidity management.
“Passive ETFs are much more widely used versus active ETFs by institutional investors while ETFs are also being used as an alternative to derivatives such as total return swaps (TRS) and futures. Various factors need to be considered such as capital requirements, counterparty risk and financing and/or carrying costs,” says Eng.
The narrative around ETFs often starts with their cost advantages as Eng acknowledges they are the least expensive vehicles to get exposure to any asset class. Fees have also been driven down further by growing competition. The Canadian ETF market alone has expanded from two providers to 42, with average fees shrinking from 20-30 basis points to as low as 10-15.
One of the most common misconceptions about ETFs, however, is mistaking trading volume for liquidity as Eng asserts ETF trading volume is not equal to ETF liquidity. “This is a crucial concept to understand when analysing ETFs and perhaps one of the most critical considerations when assessing an ETF investment,” he says.
“Some ETFs are not as actively traded and have lower assets under management. This may cause investors to look elsewhere, as they believe the liquidity in the ETF is not sufficient to trade, but this could not be further from the truth.”
ETFs are “at least as liquid as their underlying basket of securities,” Eng added. Looking at implied liquidity is “a more comprehensive way to measure how liquid an ETF versus simply looking at the average daily volume. Implied liquidity is forward-looking, whereas trading volume is backwards looking,” Eng explains.
Additionally, implied liquidity provides an indication of how much of an ETF can be traded in the future; while trading volume looks at only how much was traded in the past. He adds it evaluates the liquidity of the underlying holdings of the ETF and how many ETF shares can be traded without a bigger cost impact.
Ultimately, what determines the liquidity of an ETF is the liquidity of underlying securities, derivatives based on the ETF and different trading vehicles, such as similar ETFs, swaps, futures, options and structured products.
The Canadian ETF market remains steadfast, with significant growth since last year. In Q1 of 2023, ETF trading represented roughly 14.75 per cent of all equity trading in Canada. Fast forward to Q1 of earlier this year, that number jumped to 17.6 per cent. 2024 has also seen $600 billion of new flows going into Canadian ETF AUM, a 10 per cent increase since the beginning of the year.
Despite their increasing popularity, misconceptions persist, especially among institutions unfamiliar with the nuances of ETFs. That’s why Eng emphasizes the importance of education. “The message is to get educated, speak to ETF providers, and learn a little bit more about how ETFs can be used,” he asserts. “Learn how ETFs can be beneficial and then drill down and see what the best ETF for your purpose is.”
For those willing to look past outdated myths, ETFs can offer an array of strategic benefits. Whether for liquidity management, tactical asset allocation, or cost-efficient market exposure, Eng believes ETFs are becoming indispensable tools in the institutional investor’s toolkit. “For those who perhaps shy away from ETFs, I would suggest that they keep an open mind, because they’re coming, they’re here, and they’re growing,” Eng says. “Asset growth has been tremendous.”
