ETFs: Growing Institutional Adoption

Institutional Investor in early December hosted a webcast with investment management firm Invesco and North Carolina State University titled “Unlocking Potential: The Expanding Role of ETFs for Institutions.”

Invesco’s Garrett Glawe, Head of Asset Owner ETF Specialists, and Chris Dahlin, Factor & Core Equity Strategist, were joined by North Carolina State University Chief Investment Officer Chris Ip, to discuss recent trends in the ETF industry and three specific use ETF use cases for the endowment fund.

Fast facts

North Carolina State University (NCSU) Investment Fund:

• $2.8 billion portfolio with 3 pools of capital: a $2.3 billion long-term pool (a diversified pool endowment model that targets 5.5% real return), a $400 million intermediate-term fund (with a shorter duration of one to two years with a 2% distribution rate goal), and a $100 million Socially Responsible Investing (SRI) pool
• Investment team: Two investment analysts, one investment reporting specialist, and CIO Chris Ip
• Consultants: Graystone for public markets and Hamilton Lane for private markets

Invesco:

• $2.1 trillion global asset manager¹
• Recently hit a milestone with $1 trillion AUM in ETF and indexed strategies²

The rise of the ETF industry

• “Capital will flow where it’s treated best. It’s clear that investors think the ETF wrapper is treating their capital pretty well.” – Chris Dahlin, Factor & Core Equity Strategist

Since Covid, the size of the ETF industry has grown rapidly, Chris Dahlin said, “What I think might be more surprising is the sheer magnitude of the growth and progression of capital from inception in 1993 to about 2019; from COVID on, that flow has accelerated from $4 trillion to almost $12 trillion as of today.” Equities were clearly the early winner in the AUM migration into the ETF wrapper and still make up 80% or so of total ETF assets, however fixed income flow has begun accelerating³.

ETFs have slowly taken market share from mutual funds. Today, there is about $22 trillion in mutual fund trillion has left active mutual funds and about $1.5 trillion has moved into either index mutual funds or ETFs⁴. “Although the assets and flow into active ETFs are still dwarfed by passive flows, active is certainly starting to pick up steam and gain market share and flow,” Dahlin said.

Why ETFs?

• “It's efficient, it's cost effective, there's good liquidity, and implementation can be done quickly.” – Garrett Glawe, Head of Asset Owner ETF Specialists, Invesco

The panel agreed that the potential benefits of ETFs include their cost effectiveness, liquidity, and operational efficiency, helping asset allocators to avoid the lengthy process of hiring a new active manager.

To date, North Carolina State University currently invests in five ETFs:

• Invesco S&P 500 Equal Weight ETF (RSP)
• Invesco Nasdaq 100 ETF (QQQM)
• Invesco Senior Loan ETF (BKLN)
• Two active ETFs focused on domestic and international small-cap value

“We generally try to look for active managers, and we're generally structurally indifferent,” CIO Chris Ip said. “When we weren't able to find an active manager, we gravitated more towards the Invesco RSP ETF product, which is the equal weight product: The thesis was that typically outperforms and will catch up with the large cap.”

ETF use cases

Here are some observations from recent ETF investments by Chris Ip, Chief Investment Officer, North Carolina State University.

Invesco S&P 500 Equal Weight ETF (RSP) to help mitigate concentration risk in large-cap equities:

• “Although RSP has seen net outflows this year across all investor types, among institutional investors or asset allocators, it's actually attracted positive flows still, because I think there is concerns about concentration in the US equity market.”

Invesco NASDAQ 100 ETF (QQQM) to provide exposure to innovative technology companies and balance RSP:

• “We studied research that showed that the potential benefits of blending RSP with QQQ, because QQQ is the proxy for the large tech, and while it should broaden, we also wanted to make sure we were protected and had enough exposure to the large cap, and so far, it's been accretive.”

Invesco Senior Loan ETF (BKLN) to serve as a public proxy for private credit prior to managers calling capital:

• “We made a $10 million investment to a private credit fund, we would invest $10 million in BKLN, and when that private fund makes a $5 million capital call, we would sell the $5 million of BKLN and fund it to that capital call. If it's doing well, we can have it for the long-term pool and put it in our intermediate term fund.”

ETF future interest and product development

Chris Ip noted that NCSU is likely to use more ETFs over time.

• “As long as it's to the earlier point, efficient cost, liquid and cost efficient as well, then we see no reason why we wouldn't continue to broaden our use of ETFs.” – Chris Ip, Chief Investment Officer, North Carolina State University

Invesco’s Chris Dahlin answered an audience question about ETF product development. “It’s at the intersection of where we see client demand, flows, gaps in the lineup, and portfolio construction,” he said. “There's a little bit of art and a little bit of science to this.”

Many of Invesco’s early factor-based ETFs were focused on a single factor, like quality or low volatility. These can be important portfolio building blocks but can have a higher tracking error to the broad market. More recently, Invesco worked with a public pension plan to launch multi-factor ETFs that seek to harness the factor premium but are designed to keep tracking error relatively low.