Pension funds are increasingly implementing ETFs as low-cost, transparent tools for accessing new asset classes, according to consultants.
Towers Watson senior investment consultant Christopher Sutton says increasing numbers of pension funds are looking to diversify across asset classes, which means accessing new asset types.
He says: "A number of these pension funds go to new asset classes for the first time, with perhaps not as much knowledge and insight as to how they work.
"We are definitely seeing some pension funds using ETFs as a way to first ‘dip your toe in the water' of a new asset class."
Aon Hewitt global principal Martin Kraus says: "We think the main potential benefit of ETFs to our clients and pension funds is to give them some sort of facility to achieve the changes in medium term asset allocation which they may want to make."
He says ETFs can be used for asset allocation between different equity and bond markets, as well as to change the structure of the portfolio, for example, by giving the pension fund a bias towards large cap stocks.
He adds: "In many cases, they're a low-cost, transparent alternative, they offer great liquidity and they can have attractions for transition management and the speed with which that can be done."
Pension funds are also increasing their use of ETFs as they adopt a more tactical framework, rather than the traditional buy and hold horizon.
iShares head of institutional sales in UK and Ireland Philip Philippides says: "With a lot of the recent market events and regulation, pension funds need to be more tactical and ETFs lend themselves to that."
He explains this is because ETFs are low-cost, requiring no minimum sizes other than one share, are transparent, liquid and can also be lent out by pension funds for additional revenue.
Another factor spurring uptake is ETFs provide an efficient alternative to derivatives, which a lot of pension funds cannot use. Db x-trackers head of UK Manooj Mistry says a pension fund can use futures for a liquid benchmark, like the FTSE 100, but in order to cover a broad benchmark like MSCI Europe, a combination of futures is needed.
However, Mistry says this can introduce tracking error, as it is hard to get the perfect weighting of the different futures contracts, and roll costs are also incurred.
He adds: "With an ETF, you can get this exposure, have perfect tracking and you don't have the hassle of managing futures."
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