In its search for alpha and decrease exposure to single-stock risk, the buy side is increasingly turning to exchange-traded funds.

According to recent research from State Street Global, 85% of investment professionals are using exchange-traded funds (ETFs) to gain exposure to individual sectors or industries. More than one-quarter of survey respondents (26%) report that over 20% of their assets under management are allocated to sector/industry ETFs.

This research is based on State Street Global Advisors’ Survey of Investment Professionals’ Sector and Industry Investing Attitudes and Usage, completed in the first quarter of 2016. The study comprised web-based interviews with 419 financial advisors and wealth managers.

While it is hard to compare the two conventionally – the average daily amount of stock trading as measured by Bats Global runs around 7.30 billion shares compared to 1.3 billion for ETFs, the latter reported by SSGA. When compared on a notional dollar basis, ETFs hit $13.1 billion versus $48.5 billion for stocks.

The estimated value of all ETF shares issued exceeded that of shares redeemed by $5.60 billion for the week ended October 26, 2016, the Investment Company Institute recently reported. For ETFs backed by equities, for the week ended November 1 net issuance hit $5.23 billion for the week, compared to estimated net issuance of $2.38 billion in the previous week. Domestic equity ETFs had estimated net issuance of $4.03 billion, and world equity ETFs had estimated net issuance of $1.19 billion.

Nick Good, co-head of the Global SPDR business at State Street Global Advisors, told Markets Media that the research pointed a rosy picture for ETFs going forward. He said the survey found that the use of sector and industry ETFs is highest among private wealth managers, with 92 percent reporting they had some exposure to the sector and/or industry funds; followed by independent/regional broker dealer advisors (87 percent), National Broker Dealer advisors (86 percent) and Registered Investment Advisors (80 percent).

“The most important variables these investment professionals consider when choosing a specific sector or industry ETF are liquidity, expense ratio and the fund’s holdings,” he said.

Looking ahead, 45 percent of financial advisors surveyed report they plan to increase usage of ETFs while another 50 percent said they plan to maintain their current allocation of sector and industry ETFs in the future.

Advisors’ top reasons for incorporating sector and industry ETFs into client portfolios include:

•           Portfolio Diversification (cited by 66% of respondents)

•           Expressing Tactical Views (65%)

•           Obtaining Alpha (49%)

•           Managing Risk in the Equity Market (42%)

“With increasing volatility and uneven market performance intensifying the search for superior, risk-adjusted returns, demand for sector and industry ETFs will remain a core pillar in the industry’s growth and development.” said Dave Mazza, head of ETF and Mutual Fund Research at SSGA.

When asked what drove asset managers to add a sector or industry ETF to a client portfolio, over half of advisors surveyed cited a change in market conditions. This follows from the prevalent view of sector and industry investing as a way to benefit from specific areas of the market that are advancing or retreating.

The second most common reason for investing, cited by nearly a quarter of advisors surveyed, was third-party guidance, generally from an industry expert or product provider. According to one advisor in the report, while market conditions drive actions, “research from a variety of firms helps me identify shifts that need to be made.”

Ryan Sullivan, vice president of Global ETF Fund Services at Brown Brothers Harriman said that at their inception, ETFs were aimed squarely at retail investors who wanted exposure to multiple asset classes but could trade them in exchange fashion. But now, amid a growth spurt of products and liquidity, coupled with low cost, the buy-side is giving ETFs a chance in their portfolios.

“Larger firms are interested as liquidity and cost have become more meaningful to their own portfolios,” he said in a prior interview. “Insurance companies getting into this space.  Pension funds too have moved beyond dipping their toes into fixed income ETFs, now adding equity ETFs tracking broad indexes to their strategies.

As liquidity in ETFs has increased, it has initiated a type of demand pull effect – as demand has increased it has pulled in more issuance. This effect, Sullivan said, has led to the increased issuance and resultant demand.

“And now you increasingly have traditional investors using them as part of a long-term investment strategy,” he said. “With increased liquidity you also have ETFs becoming less of a cash-equitization strategy but more of a traditional buy-and-hold strategy for institutional investors as well.”

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