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May 31, 2011

Australian institutional investors expect to increase ETF usage, new Russell research shows

• 30% of institutions will consider using ETFs in future in a significant way
• Education and innovation will be key to evolution of institutional ETF market

SYDNEY, May 31, 2011 - Global financial services firm Russell Investments is urging Australian institutional investors to properly understand how they can use ETFs in portfolio management, and is rallying the ETF industry to focus on meeting the growing needs of the institutional market. This follows Russell's launch of a major new research report today: Digging Deeper: Institutional ETF investing in Australia which looks at how Australian institutions are using ETFs and plan to use them in the future.

While retail use of ETFs has boomed in Australia, institutional usage has lagged, which is exactly the opposite of how ETF markets have developed in Europe and the US. A recent Greenwich report showed institutional ETF usage in the US has increased dramatically over the past year and will continue to grow. To date there has been limited evidence around institutions' attitudes to ETFs in Australia so Russell engaged Deloitte Actuaries & Consultants to undertake in-depth interviews with 20 institutions that directly manage or advise on over 40% of Australian funds under management. The respondents ranged from large investment managers, superannuation funds and insurance companies to smaller investment advisers and endowments & foundations.

"While some institutions initially perceived ETFs as a retail solution; the research found that the majority of institutions use ETFs in small way, with 30% considering using ETFs in a significant way," said Amanda Skelly, director ETFs, Russell Investments. "This is a positive sign for the industry although there is still a lot more we co do to help drive growth through product innovation and education."

Getting under the skin of institutional ETF usage

While large institutions often view futures, direct mandates or low cost managed funds as superior to ETFs for purposes such as dynamic asset allocation, cash equitisation and transition management, many were able to pinpoint specific instances where they had used or considered using ETFs over these investment vehicles.

"If you're looking to hold a future for longer than three months, roll costs, loss of franking credits and basis risk may mean ETFs are more cost and tax effective. Likewise if you're looking for more precise sector exposure or exposure to hard to access markets, ETFs might also be a more effective tool," Ms Skelly said.

Large institutions also indentified other uses for ETFs; as a way to implement a temporary strategic or tactical allocation for smaller pools of capital or sub portfolios; as a tool to manage temporary investment positions; and as an option for investment platforms offered to retail investors.

Many larger institutions had also considered more innovative uses of ETFs in non-core parts of their business or for portfolios constructed for specific clients. "As institutions continue to evolve to address specific customer needs, be it managing pension assets differently, expanding the types of exposures they are seeking to access or taking a more macro approach to investing, ETFs can play a role. They should be considered alongside all other types of investment vehicles," Ms Skelly said.

For smaller institutions it is clear ETFs could play a role as a long or short term investment solution and often have both tax and cost benefits. For them, comfort with existing investment structures and processes and limited knowledge of ETFs have been the main barriers to acceptance.

Overcoming barriers and future innovation

The cost of ETFs verses other instruments was a reoccurring concern throughout the research. Yet many respondents highlighted there are certain times when ETFs can be a cost effective alternative and should be assessed on a case by case basis.

For Australian listed ETFs, lack of secondary market liquidity and market depth were concerns, with many institutions turning to overseas exchanges for ETF usage.

"While ETFs are gathering momentum, the local market is still in its infancy. It is clear we need to continually educate the market on ETFs to ensure investment decision makers are properly evaluating the role they could play in their businesses," Ms Skelly said.

Looking ahead, while the research shows it's still early days, many Australian institutions are realising ETFs can enhance the portfolio management process and will have a role in the future.

"There is a growing institutional acceptance of ETFs but how fast the market develops here will hinge on education and innovation," Ms Skelly concluded.

For a copy of the research report: Digging Deeper: Institutional ETF investing in Australia please contact Honner Media.