Beyond short-term use cases, ETFs may be well-suited to support institutional asset owners’ initiatives over the long term.
As institutions navigate regulatory shifts, ETFs can offer useful attributes that may help investment managers.
Alongside products, ETF providers can support institutional asset owners with capital markets insight, investment staff and board education, and more.
Among European institutional asset owners, ETFs have long been viewed as purely tactical investment vehicles offering simple, passive exposure to market beta. Moreover, many institutions may believe that ETFs are tools designed for the needs of retail investors. As a result, European institutions have primarily used ETFs to equitise cash, fill exposure gaps during manager transitions, adjust market exposure quickly, and implement tactical views in the short term.
These perceptions may be causing institutions to overlook ETFs’ potential as long-term strategic solutions. Thanks to their competitive total cost of ownership, flexibility, and precision, ETFs can be valuable building blocks in institutional strategic allocations.
Pension managers, insurance general account managers, and other institutional asset owners have traditionally used mandates, index funds, and derivatives for long-term allocations. These decisions have been driven by mandates’ customisation capabilities, index funds’ familiar pooled structure, and derivatives’ ability to allow for hedging and efficient market access.
ETFs may complement—and at times be more attractive than—these investment vehicles by offering a combination of attributes that can be useful for long-term implementation: competitive total cost of ownership, low tracking difference, high flexibility, and ability to incorporate Environmental, Social, and Governance (ESG) criteria (see table below).
The comparison between ETFs and traditional index funds is particularly relevant when the underlying exposures are similar. In such cases, the ETF wrapper may offer advantages, including intraday tradability, transparency, execution flexibility, and ease of use during transitions or rebalancing that index funds may not provide. For institutions managing frequent allocation changes, those enhancements can add significant value to their investment process. Furthermore, the ETF may offer a lower tracking difference versus index funds, especially when withholding tax treatment or the index replication method of the ETF enhances net performance.
ETFs |
Mandates |
Index funds |
Derivatives |
|
|---|---|---|---|---|
Total cost of ownership |
Competitive Effective management and market-making can drive tight bid-ask spreads, but management fees are an important consideration |
Low Fees may be negotiable, particularly for large investors, but setup and governance costs can be meaningful |
Wide range Can be cost efficient, though pricing and access may vary by provider and share class |
Varies Can be efficient for certain exposures, but roll costs, collateral management, and operational complexity matter |
Tracking difference |
Low Designed to closely track the performance of an index excluding management fees and related costs |
Varies Customisable but tracking ability depends on mandate design and manager execution |
Low Structured to track indices tightly, but often priced once daily at the end of the day |
Varies Can track broad exposures efficiently, but basis risk and contract terms vary |
Flexibility |
High Intraday trading and liquidity can support rebalancing, transitions, and strategic uses |
Intermediate Customisable but less flexible to establish, modify, or terminate |
Intermediate Familiar structure, but do not allow for intraday implementation |
Intermediate Flexible where liquid contracts exist, but not all asset classes are accessible and exiting or rolling a position can be costly |
ESG criteria |
High Index-based ETFs can provide transparent, rules-based ESG exposure; large institutions may also explore co-developed strategies |
High High customisation potential depending on manager capabilities |
Varies ESG options available, depending on provider and structure |
Low ESG implementation may be limited by available contracts and exposure design |
Source: Invesco. For illustrative purposes only.
Many investment committees and governance boards treat ETFs similarly to equities for approval purposes: ETFs covering strategies or asset classes that are already permitted in an institution’s investment policy statement do not require additional approval to be added to the portfolio. As a result, ETFs can reduce the operational burden associated with manager searches, mandate negotiation, onboarding, or frequent rebalancing, activities that often weigh on institutional asset owners when employing mandates, index funds, and derivatives.
These benefits, along with intraday trading and daily transparency into holdings, allow ETFs to support faster decision-making, clearer exposure monitoring, and simpler communication with boards and investment committees.
For pensions, the evolution from DB to DC models across parts of Europe is another reason ETFs are garnering heightened attention. As pension systems move toward more individualised and lifecycle-oriented structures, portfolios may need more frequent monitoring, precise rebalancing, and scalable building blocks—all of which can be accomplished with ETFs.
New Dutch pension law (Wet toekomst pensioenen) offers a useful example. Under the new DC-based pension system, target allocations may need to be monitored and adjusted more frequently as lifecycle effects, premium inflows, benefit payments, and market returns affect portfolio positioning. ETFs can support that process, particularly where institutions need liquidity, attractive performance, cost efficiency, intraday tradability, low tracking difference, and operational simplicity. In fact, in a global survey of institutional asset owners—including those in the Netherlands—more than half of respondents cited liquidity, performance, and lowest total cost as their top criteria for making allocations to ETFs (see below).
That does not mean ETFs are the answer in every case. Futures may be appropriate where liquid contracts exist, and costs are lower. Index funds or mandates may be better suited for structural or highly customised exposures. But for pensions navigating more dynamic allocation requirements, ETFs may be a useful addition to the long-term toolkit.
Regulatory developments are also expanding ETF use cases for insurance general account managers. Recent and proposed Solvency II reforms are expected to reduce capital charges for certain senior securitisation exposures, including AAA-rated Collateralised Loan Obligations (CLOs), by up to 70%–80%. As a result, structured credit is potentially becoming increasingly relevant for European insurers.
While ETFs already offer transparency and support look-through treatment today, the application of reduced capital charges to AAA-rated CLO ETFs is subject to meeting Solvency II look-through requirements and depends on the insurer’s ability to access and report underlying holdings on a regular basis.
Where these conditions are met, AAA-rated CLO ETFs can provide insurers with efficient and transparent access to the asset class’s benefits—such as attractive yields, limited impairment history, and diversification potential—while supporting look-through, liquidity, and governance requirements.
For some institutional asset owners, the opportunity for ETFs goes beyond just replacing one passive exposure with another. As investment managers look for attractive opportunities beyond market-cap beta, asset managers are developing strategies that help asset owners access traditionally hard-to-reach markets, such as contingent convertible bonds (CoCos), AT1s, and parts of the high-yield market. Other areas of development include actively managed, thematic, and factor-based strategies that provide access to additional sources of alpha and portfolio construction efficiency.
In addition to providing unique market access, asset managers have also developed sophisticated market replication techniques through synthetic ETFs. In a synthetic ETF, the fund may hold a basket of securities and use a swap agreement to receive the return of the target index, rather than holding every index constituent directly like a physical fund. This synthetic structure may produce a lower tracking difference compared to physical ETFs, which is mainly attributed to the 0% withholding tax rate that is applied to US dividends through this index replication method.
For example, a synthetic ETF seeking to track a global equity index may be able to reduce tracking difference versus comparable physical ETFs by using swaps and benefiting from more efficient withholding tax treatment on US dividends. This can support closer index performance before fees, although institutions should assess the swap structure, counterparty controls, transparency, and overall costs before investing.
ETF issuers can play an important role as larger institutions seek more tailored exposures, including strategies designed around specific sustainability objectives, index requirements, or implementation needs. Alongside product development, asset managers have extensive teams of ETF and capital markets specialists who can explain product structure, index methodology, trading approach, liquidity, and performance attribution. These specialists can support institutional asset owners with pre-trade analytics to estimate cost and market impact, post-trade analysis to review execution quality, and education for CIOs, boards, and investment committees.
These capabilities can be especially important when institutions are evaluating more complex exposures, large trades, different replication approaches, or total cost of ownership. In those cases, capital markets guidance, trade planning, liquidity insights, and performance attribution can help institutions understand not only what they own but also how efficiently they access it.
Middle East tensions unsettled markets in March, yet European ETFs attracted US$12bn, driven by diversification away from the US and cautious demand for cash and short-duration fixed income.
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