Executive Summary

Allocations to exchange-traded funds by current ETF investors increased to 23% of total assets in 2018, up from 14% in 2017, among the 51 institutional ETF investors participating in Greenwich Associates most recent Asian Exchange-Traded Funds Study. This growth was driven by four powerful trends:

  • Portfolio Repositioning: A dismal year in Asian equities and a surge in global market volatility forced Asian institutions to reposition portfolios. As they did so, they increased their investments in ETFs, which served as a flexible tool for rapidly implementing tactical adjustments and strategic shifts across asset classes. 
  • Indexation: The continued shift of assets from active management to index strategies created strong demand for ETFs, the vehicle of choice for index exposures for 9 out of 10 study participants.
  • Bond ETF Boom: Investors in bond ETFs increased allocations to the funds last year by over 50% on average, to more than a quarter of total fixed-income assets. Driving this shift was investors’ continued search for a reliable source of fixed-income market liquidity.
  • Smart Beta Adoption: Smart beta ETFs are now used by 70% of Asian study participants. A third of those respondents plan additional increases to factor-based ETF allocations in 2019, with a majority of those expecting to boost allocations by more than 10%.

These trends are expected to remain in place and push ETF investment even higher in 2019. We are projecting continued strong growth in the next 12 months not only in fixed income, but also in equities, where nearly half of ETF investors in the 2018 study are planning to expand ETF allocations in the coming year.


Allocations to exchange-traded funds by current ETF investors increased to 23% of total assets in 2018, up from 14% in 2017, among the 51 institutional ETF investors participating in Greenwich Associates most recent Asian Exchange-Traded Funds Study. This growth was driven by four powerful trends:

  • Portfolio Repositioning: A dismal year in Asian equities and a surge in global market volatility forced Asian institutions to reposition portfolios. As they did so, they increased their investments in ETFs, which served as a flexible tool for rapidly implementing tactical adjustments and strategic shifts across asset classes. 
  • Indexation: The continued shift of assets from active management to index strategies created strong demand for ETFs, the vehicle of choice for index exposures for 9 out of 10 study participants.
  • Bond ETF Boom: Investors in bond ETFs increased allocations to the funds last year by over 50% on average, to more than a quarter of total fixed-income assets. Driving this shift was investors’ continued search for a reliable source of fixed-income market liquidity.
  • Smart Beta Adoption: Smart beta ETFs are now used by 70% of Asian study participants. A third of those respondents plan additional increases to factor-based ETF allocations in 2019, with a majority of those expecting to boost allocations by more than 10%.

These trends are expected to remain in place and push ETF investment even higher in 2019. We are projecting continued strong growth in the next 12 months not only in fixed income, but also in equities, where nearly half of ETF investors in the 2018 study are planning to expand ETF allocations in the coming year.

Introduction

Allocations to exchange-traded funds (ETFs) in Asian institutional portfolios increased sharply last year, rising to 23% of total assets in 2018 from 14% in 2017 for ETF investors among the 51 institutions participating in Greenwich Associates most recent Asian Exchange-Traded Funds Study. Allocations were relatively consistent across different types of ETF investors, with Asian asset managers and insurance companies allocating an average 24–25% of total assets, and institutional funds allocating 19%. By asset class, the strongest growth came in fixed income, where ETF investors increased average allocations by over 50%, to more than a quarter of total assets.

These allocation increases, which mirrored growth recorded in the United States, Europe and Latin America, helped drive growth in overall ETF fund flows. The $315.8 billion of global inflows into U.S.-listed ETFs in 2018 represented the second biggest year ever, behind only the $467.1 billion recorded in 2017.

One of the key drivers of ETF growth last year was the continued migration of institutional assets from active management to index strategies. The main beneficiaries of this trend are ETFs—the primary vehicle used by study participants for index exposures.

Also contributing to the upswing of demand for ETFs among institutions in Asia and around the world was last year’s surge in volatility. As institutions repositioned their portfolios to address volatility and market drawdowns, many relied on the flexibility of ETFs to implement specific changes. “ETFs provide better speed of trading and investing, they are easy to use, they have lower costs, and there is lower risk in selecting a fund product,” says a portfolio manager for a South Korean insurance company, explaining why his firm increased its ETF investments last year.

In particular, the spike in volatility caused an increase in the use of ETFs for short-term, tactical tilt by institutions responding to rapid market fluctuations. The use of ETFs for tactical portfolio adjustments increased to 63% of Asian study respondents in 2018, up from 51% in 2017. (Three-quarters of the Asian investment managers in the study are using ETFs for tactical portfolio adjustments.) Usage also increased in other tactical functions like interim beta and cash equitization, bringing the mix of strategic versus tactical ETF holdings in Asian portfolios to roughly 50–50 for the year.

However, last year’s increase in tactical employment did not disrupt the broader trend of institutions around the world adopting ETFs as a vehicle for achieving long-term, strategic exposures. Case in point: The share of Asian institutions using ETFs to achieve long-term “core” investment allocations increased to 63% in 2018 from 49% in 2017 and 42% in 2016. Nearly 70% of Asian investment managers in the study use ETFs for core allocations. Another 43% of respondents overall use ETFs for portfolio completion—a finding that suggests institutions are using the funds as a primary means of filling in gaps in their strategic allocations. Separately, 55% of Asian respondents are using ETFs to achieve international diversification in their portfolios, another inherently strategic function.

Based on our research in institutional markets with a longer history of ETF use, we expect growing numbers of Asian institutions to start using ETFs as a primary vehicle for obtaining long-term strategic exposures. In the United Sates, 70% of study participants report average ETF holdings periods of one year or longer—the typical threshold for what is considered a “strategic” asset. In Asia, only one-third of institutions in 2018 reported average ETF holding periods of that length.

ETFs provide

All of these trends are expected to push institutional ETF allocations higher in 2019. Between 40% and 50% of study participants expect to increase ETF allocations in equity and fixed-income portfolios.

We also expect ETFs to continue attracting new users from the universe of Asian institutions. Among the small handful of study participants that do not currently invest in ETFs, a large majority say they are somehow prevented from using the funds. Of this group, 80% say ETFs are not an approved vehicle within their organizations. Another 20% say portfolio investment guidelines/methodology do not permit the usage of ETFs, and 20% report they are prohibited from using ETFs by some other rules or factors. In addition, 20% of non-users say they do not understand how ETFs work within the context of an institutional portfolio.

Based on these results, we expect to see a continued flow of new entrants, as Asian institutions that have watched their peers use ETFs safely and effectively learn about ETF applications and benefits and remove internal prohibitions—and as ETF providers connect with institutions across the region to provide education and support regarding ETF use.

Managing Risks and Sourcing Returns

2018 was the worst year in a decade for Chinese stocks, which were hit with the damaging one-two punch of a trade war with the U.S. and a slowing domestic economy. The more than 24% annual decline in Chinese stocks set the stage for an almost equally dismal year for other Asian markets, with Hong Kong’s Hang Seng Index falling nearly 14%.

Although stocks recovered in January in key markets like China, South Korea and Japan, there is no doubt that the prospects of weakening investment returns are causing sleepless nights for institutional investors across the region. While their counterparts in Europe and the U.S. have elevated risk management to their top priority for 2019 following the volatility of last year, Asian institutions remained focused on returns. Almost 80% of study participants rank “finding attractive investment opportunities that deliver good investment returns” as a key challenge for the year ahead, versus approximately 60% citing “managing risk return that is in line with objectives/ outcome.” (Asian institutional funds participating in the study diverge from their regional peers and align with institutions in the U.S. and Europe by ranking risk management above sourcing attractive returns in terms of priorities for the year ahead.)

At the heart of these fears of weakening returns is the prospect of economic recession, which is cited as a top risk to portfolios by approximately 70% of study participants. In addition to signs of an economic slowdown in China, Asia institutions are worried about the effects of central bank tightening—most likely centered around concerns about additional hikes by the U.S. Federal Reserve and subsequent U.S.-dollar strengthening and the potential negative consequences of geopolitical events. Topping institutions’ list of geopolitical risks is the ongoing trade war between the U.S. and China. Respondents also point to the risk of a disruptive debt crisis in China and the impact of Brexit and EU fragmentation on global markets. Across the board, Asian institutions express higher levels of concern about these issues than their counterparts in Europe and the U.S.

As Asian institutions reposition their portfolios to address these challenges and access sources of attractive investment returns, they are making greater use of ETFs to implement specific changes. The resulting demand is fueling a sizable increase in institutional allocations to ETFs. As an investment analyst for a Thai life insurance company explains, “We have many options available in the market, but we still go with ETFs.”

Global Indexation Trends Drives Demand for ETFs

One of the main drivers of ETF investment among institutions around the world has been the shift of assets from active management to index strategies. The institutions in the Asian ETF Study have approximately one-third of total assets invested in index strategies. Allocations are highest at 40% among investment managers and lowest at 24% among institutional funds.

For the vast majority of Asian institutions, any growth in indexing brings a corresponding increase in ETF investments. The reason: 90% of study participants name ETFs as their preferred wrapper for index exposures.

As a result of this industrywide preference, a substantial portion of last year’s increase in ETF allocations came at the expense of active investment vehicles. More than half of study participants overall and 70% of the institutional funds say they have used ETFs to replace other vehicles. Among that group, 35% have used ETFs to replace individual stocks, and 30% have used them to replace active mutual funds.

However, a bigger portion of that total—45% of institutions that have used ETFs to replace other vehicles—say ETFs have displaced index mutual funds. That finding suggests recent growth in ETF allocations can be attributed not only to the migration of assets from active management to index strategies, but also to the choice by a growing number of Asian institutions to adopt ETFs as a vehicle for obtaining index exposures. A portfolio manager for a multi-asset fund in Taiwan explains that his firm prefers ETFs because they are “cheap, the settlement time is only two days, and there is a lot of granularity within the ETF space.”

The indexation trend is far from over. Currently, institutions in the study invest an average 35% of equity assets in index strategies. However, roughly half of study participants and 60% of investment managers set their optimal target for index allocations in equity portfolios north of 50%. In fixed income, where respondents invest an average 30% of total fixed-income assets to index, 57% of study respondents say their optimal target allocation for index strategies is higher than current levels, with a quarter of participants setting their targets at more than half of total fixed-income assets.

Liquidity Leakage Brings Boom in Bond ETFs​

Institutional allocations to bond ETFs rose dramatically last year and are on course for additional growth in 2019. ETF allocations in Asian institutional fixed-income portfolios have been on a sharp upward trajectory, increasing to 26% of total assets among study participants in 2018 from 17% last year and just 6.6% in 2016. (At 41% of fixed-income assets, current allocations are highest among investment managers in the study.)

Asian institutions are adding ETFs to fixed-income portfolios for one primary reason: liquidity. Around the world, institutions have been concerned about reductions in fixed-income market liquidity since the global financial crisis. Since that time, institutional investors have sought alternative sources to supplement the diminished liquidity provided by sell-side fixed-income dealers. For many, ETFs have servedthat role. “I prefer ETFs, as they are highly liquid and, at the same time, pricing is transparent,” explains a study participant from a Japanese investment management firm.

About 43% of current Asian ETF users invest in bond ETFs. That relatively consistent level of usage ranks ETFs among institutions’ mainstream sources of fixed-income exposures, behind individual bonds (41%) and active mutual funds (37%). However, based on past trends in other markets and investors’ ongoing search for reliable sources of fixed-income liquidity, we expect ETF usage rates to increase in Asia. In the U.S., ETFs rank second only to individual bonds as a means of taking on fixed-income exposures. Asia seems to be moving at least gradually in the same direction. Twenty percent of current ETF non-users in the Asian study say they are at least somewhat likely to start investing in bond ETFs in the coming year, up from just 12% in 2017.

Increased adoption rates could lead to substantial growth in overall investment levels, given the fact that Asian institutions that do invest in bond ETFs allocate such relatively large shares of fixed-income assets to the funds and are actually planning to increase allocations further in the next 12 months. Among respondents, 40% plan to increase existing allocations in the coming year, and not a single study participant has plans to reduce allocations. Those increases could be exceptionally large. Among institutions planning to boost allocations to bond ETFs, 60% are planning increases of 10% or more.

Smart Beta: A Major Factor in ETF Demand

The growing appetite for factor-based investment strategies has emerged as an important and consistent source of institutional ETF demand in Asia, and study participants here appear to be planning for another significant increase in smart beta allocations in 2019.

Over seventy percent of Asian study participants overall and 80% of the institutional funds now invest in factor-based ETFs. Given institutions’ concerns about equity market drawdowns and volatility, it’s hardly a surprise that minimum-volatility ETFs are the most popular smart beta products, used by 62% of investors, or that dividend/equity income ETFs come in second at 52%.

About one-third of smart beta ETF investors overall and half the investment managers expect to increase allocations to factor-based strategies in the next 12 months. (Only 3% of current investors expect to cut allocations.) Of institutions planning an increase, a striking two-thirds expect to boost allocations to smart beta ETFs by 10% or more.

What’s driving this strong growth in demand among existing investors? Approximately three-quarters of smart beta ETF investors in the study say they now have a good understanding of how to implement factor strategies in their portfolios, up sharply from just 14% in 2017. This upswing is likely attributable to the growth in educational efforts by ETF providers, as well as recent market volatility spurring interest in products like min-vol and factor-based ETFs. With this increased level of comfort, 58% of investors planning to expand allocations say are doing so because they have developed views on specific factors, such as momentum or growth, that they want to implement in their portfolios.

Nevertheless, there is still more providers can do to stoke additional demand. Among current ETF investors in the study, 27% say they could use more information and support about how to use smart-beta ETFs in their portfolios. By delivering this type of educational service, ETF providers have an opportunity to attract even more institutional investors to factor-based strategies.

Expanding Equity ETF Allocations

ETFs are the most popular means of obtaining equity exposures among the institutions participating in this year’s study. More than threequarters of study participants use ETFs for equity exposures, topping the 63% using active mutual funds and 55% investing in individual stocks. Usage rates have been climbing steadily and should continue to advance in 2019, with 27% of non-users in the study saying they are at least somewhat likely to start investing in equity ETFs in the coming year.

Asian institutions that invest in equity ETFs allocate 34% of equity assets to the funds—a share about on par with allocations among U.S. institutions and larger than the 28% reported by study participants in Europe.

As in fixed income, institutions say they are increasing their investments in equity ETFs primarily to take advantage of a set of benefits that make them easy to use as both tools for tactical portfolio tasks and sources of long-term or strategic investment exposures. Among the specific benefits cited by study participants are ETFs’ speed of execution in gaining diversified investment exposures, enhanced liquidity and reduced trading costs relative to individual stocks. “Equity ETFs enable us to invest in equities without being mindful of which shares might pose specific risks,” says a study participant representing a major Japanese bank.

Those advantages will continue to attract institutional assets in 2019. Almost half of study participants (48%) plan to increase existing equity ETF allocations in the next 12 months. Thirty-eight percent are planning increases of more than 10%, and nearly 9 out of 10 plan to expand by at least 5%.

It should be noted that 12% of existing equity ETF investors in the study plan to reduce allocations in the next year. However, these plans appear to be driven at least in part by broader shifts in portfolio allocation in the face of changing market conditions and mounting risk. More than a third of institutions planning reductions to equity ETF allocations are doing so as a means of reducing overall equity asset class exposure.

ESG: Outperformance Could Overcome Ambivalence

Asian institutions are divided in their views on environmental, social and governance investing—a result that isn’t too surprising in light of the heterogeneity of the many markets, regulatory regimes and cultures that make up the vast Asian region. Although 44% of respondents think investors have a growing responsibility to address issues like climate change and diversity because governments are not doing enough, 54% say they simply see no reason to consider ESG factors in investment decisions.

In both Asia and the United States, just shy of a quarter of study respondents say they have sold out of or invested in a certain strategy as a result of ESG considerations. In those terms, both Asian and U.S. institutions trail their European peers, 44% of which have altered their investment processes or portfolios as a direct result of ESG.

Asian and U.S. institutions also fall far short of their counterparts from Europe when it comes to expectations about how much influence ESG will have on their portfolios in the future. In Europe, nearly 50% of study participants predict they will be managing half of total assets with ESG criteria within the next five years. Only 6% of Asian study participants expect to hit that mark, with two-thirds of Asian respondents predicting that ESG will make up only 0–5% of total assets in 2024.

However, there is at least one important reason to believe that ESG investing will gain traction among Asian institutions: 42% of Asian study participants overall and half of the investment managers think ESG overlays and investments will increase the likelihood of strong investment returns over the long term. That share is about equal to the percentage of European institutions taking that bullish view, and nearly double the share of U.S. institutions that think ESG investing will enhance long-term performance. Given the focus Asian institutions are placing on investment returns, we think ESG could gain additional traction in the region in 2019, as investors seek sources of outperformance.

Selecting ETFs and ETF Providers

When it comes to selecting a specific ETF for investment, Asian institutions consider a wide range of criteria, starting with liquidity/ trading volume of available funds, followed by expense ratio and past performance, including tracking error. Also taken into consideration are factors like the AUM of the ETF, and how well the fund matches the investor’s exposure needs.

Alongside these factors, institutions also scrutinize the fund company and management behind the ETF. As they increase ETF allocations, Asian institutions are paying more attention to the tools, service and educational support provided by the companies behind the funds in their portfolios. As an example, one-third of study participants overall and 42% of the institutional funds say they are seeking additional information and support from providers about how to implement bond ETFs in their portfolios.

Based on all these criteria, iShares/BlackRock has cemented its position as the ETF provider of choice to Asian institutions. Of the ETF investors participating in this year’s study, 88% use iShares/BlackRock as a provider. State Street/SPDRs ranks second at 68%. While iShares/BlackRock is runner-up to Vanguard when it comes to “value for management,” study participants name the firm as the market’s No. 1 provider in all nine of the other the product and service categories covered in the study, ranging from liquidity and transparency of products to service platform, innovation and range of products.

Methodology

Between October 2018 and January 2019, Greenwich Associates interviewed 51 Asian institutional investors for its 2018 Asian Exchange-Traded Funds Study— the fourth edition of our benchmark annual research program. The research sample, which includes 40 current ETF investors and 11 non-users, is made up of 19 investment managers, 18 insurance companies and 14 institutional funds. Among the institutional funds are corporate defined-benefit and definedcontribution pension plans, public defined-benefit plans, sovereign wealth funds, endowments, foundations, and family offices. Most of the participants are large institutions: 40% have assets under management (AUM) of $10 billion or more.