Pension fund and insurance company use of ETFs surges in Europe

Institutional adoption of exchange traded funds by asset owners such as pension funds and insurance companies has accelerated in Europe since 2020, according to BlackRock’s analysis of its own iShares ETF ownership.

There has been a compound annual growth rate of 29 per cent since 2020 in the value of iShares held by the largest European institutions, said Kirst Kuipers, head of institutional iShares sales Emea and head of official institutions sales Europe.

“This is a very fast growth rate,” he said.

He said holdings databases for large asset owners offered a high degree of transparency, allowing BlackRock to build an accurate picture about iShares ownership.

They revealed that, on average, in the 16 European countries BlackRock surveyed, 40 per cent of the 10 largest pension funds in each country owned iShares ETFs. This number obscured some regional variation, with the vast majority of the largest pension funds in some countries holding ETFs.

That percentage of ownership rises to 60 per cent if other large asset owners, eg insurance companies, are also included.

BlackRock’s observations on the jump in institutional client interest are echoed by other market observers in Europe.

“Traditional institutional clients, such as pension and insurance firms, are increasingly active on our European ETF platform,” said Adam Gould, global head of equities at Tradeweb, which provides electronic over-the-counter marketplaces for trading fixed income products, ETFs and derivatives.

Gould said total notional volumes attributed to institutions had risen by 104 per cent over the past four years. “The number of pension and insurance firms trading ETFs on our platform has also gone up by 75 per cent,” he said.

Kuipers said there were a number of drivers for the increased enthusiasm for ETFs in institutions.

Firstly, the vehicles demonstrated their resilience to market shocks during the meltdown that accompanied the start of the pandemic. The sheer increase in liquidity in the ETF market had also made a difference, he said, pointing to the jump in global ETF assets under management over the past decade from about $2.5tn to $14tn today.

Also, for certain fixed income ETFs, for example, huge cost savings could be achieved by trading the ETF vs trading the underlying securities. Kuipers calculated that over the past three months a trade of $50mn on the iShares Core € Corp Bond Ucits ETF (IEAC), which quotes a total expense ratio of 20 basis points, would have cost 3bp vs 27bp for trading the underlying securities.

Even greater cost savings could have been achieved on a similar sized trade for the iShares € High Yield Corp Bond Ucits ETF (IHYG), which quotes a TER of 50bp, where it would have cost 5bp to trade the ETF vs 60bp for the underlying.

He added that this advantage would evaporate should an institution be looking to perform a larger trade of, say, $500mn, when the economics of scale would make it cheaper to use the bespoke deals that could be negotiated under a mandate.

These cost differentials might explain further trends that Kuipers had observed, for example that smaller asset owners were increasingly using ETFs in their buy-and-hold strategies. But he said ETFs were being used to complement mandates and had proven themselves as cost-effective tools to balance portfolios even among larger institutions.

“They are not doing it all with ETFs but they are more willing to use them,” Kuipers said.

BlackRock is predicting an acceleration in the shift from defined benefit schemes to defined contribution plans and expects this, too, to create a surge in pension fund demand for ETFs.

“We will see new DC schemes emerging,” said Kuipers. “As new ones set up, we expect them to choose to use ETFs — ETFs are particularly relevant for new DC schemes that need to be diversified from day one,” he added.

Amin Rajan, chief executive of Create-Research, a consultancy that works closely with the pension fund industry, said he was not surprised by BlackRock’s figures.

He pointed to a further factor that was driving pension fund adoption of ETFs — the big shift towards passive index investing from active management in the past.

He said his own research suggested that about 10 years ago pension funds globally held about 15-20 per cent of assets under management in passive funds of all kinds. That figure had jumped to 35-40 per cent.

The increasingly low fees demanded by ETFs meant they were more and more becoming an instrument of choice for pension funds, over traditional index funds.

In addition, Rajan said: “ETFs have become a hedging tool because you can move in and out without affecting the underlying share price too much.”

Kuipers said the sudden jump in interest from large asset owners marked a transformation of the ETF market.

“Wealth [management] was first, then asset managers, now we’re moving to asset owners,” he said.