Institutional investors in Asia are increasingly using exchange-traded funds (ETFs) for strategic as well as tactical allocations, according to a Greenwich Associates study* due to be released today.

Drivers of increased ETF usage include futures replication, multi-asset and smart-beta exposure, with fixed-income products expected to see more flows due to reduced bond liquidity, noted Greenwich.

This was the research house's first separate ETF study for Asia and it was based on interviews with 52 Asia-based institutional investors (including fund managers), 31 of which use ETFs. 

The results reflect that asset owners in the region, including insurers, official institutions and “large balance-sheet investors”, are moving portfolios into international equities and bonds, said Geir Espeskog, head of Asia-Pacific distribution at BlackRock, which sponsored the study.

Asia is now on the cusp of an accelerated growth phase, such as happened previously in Europe and the US, now that institutions are realising how ETFs can replicate these asset holdings at lower cost, Espeskog told AsianInvestor.

For example, he said, Asian insurers are now using ETFs to manage surplus and reserve assets.

Moreover, two-thirds of respondents said they used futures to access beta, but Asian institutions are now replacing futures positions with ETFs. Half of the ETF users polled planned to replace an equity futures position with an ETF in 2016. Another 20% said they were evaluating futures positions for possible replacement with ETFs in the year ahead.

“This suggests that the funds are taking their place in institutions’ standard portfolio-management toolboxes,” said Espeskog.

In the short term, ETF growth will be driven by equities, said the Greenwich report, as fixed income usage is still relatively low: 94% of ETF users polled use ETFs in equity portfolios, and less than a third do so for fixed income.

The two most common uses of ETFs among Asian institutions are strategic – gaining international diversification and obtaining exposure for core allocations. But 53% of institutions also make tactical adjustments to their portfolios with ETFs, while a third also use them for rebalancing and/or portfolio completion.

The pick-up in fixed income will come once the market is more well established, suggested the report. In North America, deterioration in fixed-income market liquidity is fuelling demand for bond ETFs. If global fixed-income dealers cut back on their market-making activities in Asia to the extent they have in the US, Greenwich expects the Asian market to follow a similar path, with concerns about liquidity driving institutional demand for ETFs.

However, the findings are not conclusive about a regional trend in fixed income ETFs. Moreover, some active fund managers have told AsianInvestor they would not want to use certain bond ETFs due to a lack of underlying asset liquidity.

Meanwhile, nearly 30% of Asian institutional users of ETFs plan to boost smart-beta allocations in the coming year, while some 60% of current users intend to invest in minimum-volatility ETFs and about a quarter into single and multi-factor ETFs. Smart or enhanced-beta products use indexes based on factors other than traditional market-capitalisation weighting to achieve additional returns over beta.

Moreover, the growing popularity of multi-asset strategies represents an important source of future growth for ETFs among Asian institutions, noted Greenwich. Some two-thirds of fund managers in the survey are using ETFs in multi-asset products.

Greenwich expects Asian institutional ETF allocations to gravitate from about 5% of the investment portfolio towards the 15% average for institutional ETF users globally. 

*Respondents were based in Hong Kong, Japan, Korea, Singapore and Taiwan and included 16 institutional funds (corporate pensions, public pensions, foundations and endowments), 15 insurance companies and 21 asset management firms.