ETFs: Active Tools for Institutional Portfolios

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1 Q1 Month Cover Headline Here (Title Case) ETFs: Active Tools for Institutional Portfolios Cover subhead here (sentence case)

2 CONTENTS 3 Executive Summary 4 Introduction: Active Tools for Portfolio Management 5 ETFs Are Efficient Long- and Short- Term Exposure Vehicles ETFs HAVE BECOME A MAINSTAY WITHIN INSTITUTIONAL PORTFOLIOS ALONGSIDE STOCKS, BONDS AND DERIVATIVES 52 % OF STUDY PARTICIPANTS INVESTING IN ETFs HAVE REPLACED A DERIVATIVE PRODUCT WITH AN ETF 6 ETF Trading Advantages Seen as Top Benefits 7 ETFs as a New Class of Financial Instrument 8 Using Smart Beta to Address Key Challenges 9 More Growth Ahead 12 Impediments to ETF Use Continue to Dissipate 15 Conclusion METHODOLOGY Between October 2016 and January 2017, Greenwich Associates interviewed 187 institutional investors for its 2016 U.S. Exchange-Traded Funds Study. That research sample encompassed a wide range of institutions, including 50 institutional funds, 48 asset managers, 29 insurance companies, five investment consultants, and 55 RIAs. Participants in this year s study manage a total $6.668 trillion in assets. Over a third have assets under management (AUM) of more than $5 billion, about one-quarter manage more than $20 billion, and 10% have AUM in excess of $100 billion. Managing Director Andrew RESPONDENTS McCollum advises on the investment management BY AUM BY TYPE market globally. 10% 6% 7% 29% 27% 63% 14% 3% 15% 26% Over $100 billion $ billion $ billion $ billion $5 billion and below Institutional funds Asset managers Insurers Consultant RIAs 2 GREENWICH ASSOCIATES

3 Executive Summary Institutional assets are flowing into exchange-traded funds (ETFs) as U.S. institutions integrate them into essential portfolio functions ranging from risk management and liquidity enhancement to the generation of income and yield. As such, ETFs appear to be on track to eventually becoming as common in institutional portfolios as stocks, bonds and derivatives. This steady advance of ETFs within institutional portfolios is one of the main findings of the Greenwich Associates 2016 U.S. Exchange-Traded Funds Study, which focuses primarily on the investment behavior of U.S institutions currently investing in ETFs. Although only about 1 in 5 U.S. institutions overall currently invest in ETFs, those that do generally have multiple years experience investing in the funds. These institutions see ETFs first and foremost as tools for obtaining strategic investment exposures, often holding them alongside stocks, bonds, and derivatives. However, investors are also taking advantage of ETF traits like liquidity, ease of use and quick market access to apply the funds across a broad and expanding range of portfolio applications. Overall, institutional ETF users invest an average of 21% of total assets in ETFs up from 19% in Those allocations are likely to grow in Forty-seven percent of equity ETF investors and 38% of bond ETF investors expect to increase their allocations to the funds in the year ahead. Demand is being fueled by several powerful trends: JJ JJ JJ JJ JJ ETFs are being viewed as a new class of financial instrument. In addition to using ETFs alongside other vehicles in their portfolios 52% of institutions that use derivatives to access beta say they have replaced an existing derivatives position with an ETF in the past year, and one-third of the institutions in the study plan to do so in the next year. ETFs have evolved within institutional portfolios from a complement to mutual funds to an alternative to derivatives with unique benefits of their own. Institutions are using smart beta ETFs to address challenges in their portfolios. Growing numbers of institutions are turning to innovative ETF exposures to help navigate the challenges posed by low interest rates and increasing market volatility. The share of institutional ETF users investing in smart beta ETFs increased to 37% in 2016 from 31% in The two most popular fund types in this category are minimum-volatility ETFs and dividend/equity-income ETFs. The strong demand for these funds is reflective of the challenges facing institutional investors today, including the need for yield and concerns about increased market volatility in the current rate environment. Of institutions currently investing in smart beta ETFs, 44% plan to increase their allocations to the funds in the next year. Demand for ETFs is being fueled by the growth in multi-asset funds. Fifty-two percent of the asset managers in the study use ETFs as part of multi-asset funds managed for clients. That share is up sharply from the 35% of asset managers employing ETFs in these funds in Bond ETF adoption is closing the gap on equity ETFs. In 2016, assets in U.S.-domiciled bond ETFs grew by nearly 26% to $428 billion, far outpacing the 18% growth in U.S. equity ETFs. 1 In addition to the 38% of current bond ETF users expecting to increase allocations, 17% of current non-users are considering investing in the funds in the year ahead. Past impediments to institutional use are giving way. Factors that in the past limited institutional investment in ETFs appear to be receding. Fewer institutions are expressing concerns about ETF liquidity and expenses. In fact, many institutions are introducing the funds into their portfolios specifically to enhance liquidity and reduce costs. Meanwhile, explicit prohibitions or limitations against ETF investments are becoming less common in both equities and fixed income. In 2015, nearly a quarter of non-users said they were prevented from investing in fixed-income ETFs by internal investment guideline restrictions. That share fell to 19% in Source: Bloomberg, as of 12/31/16 3 GREENWICH ASSOCIATES

4 Introduction: Active Tools for Portfolio Management U.S. institutions use exchange-traded funds first and foremost to obtain investment exposures, including strategic core exposures and exposures intended to diversify portfolios. However, the institutions participating in the Greenwich Associates 2016 U.S. ETF Study are also using ETFs in more tactical applications due to their enhanced liquidity, ease of use and low-cost. ETFs are emerging as important active tools for institutions. In fact, growing numbers of institutional investors are employing these largely passive products to proactively construct, maintain and adjust portfolios on a day-to-day basis. As the CEO of a U.S. asset management firm stated, ETFs are the cheapest and most efficient way to implement active strategies. The versatility attracting institutions to ETFs is evident in the list of the three most common applications for the funds among the institutions participating in the study. At the top of the list is making tactical adjustments to a portfolio. The next two applications obtaining investment exposures in the core components of a portfolio and achieving portfolio diversification are largely strategic functions. Between these two extremes, institutions are integrating ETFs into functions ranging from rebalancing and portfolio completion to transition management, cash equitization and interim beta. KEY USES OF ETFs IN U.S. PORTFOLIOS Tactical adjustments Core allocation International diversification Rebalancing Portfolio completion Liquidity management Risk management/ Overlay management Transition management Cash equitization Interim beta Note: Based on 148 responses. Source: Greenwich Associates 2016 U.S. Exchange-Traded Funds Study 23% 20% 59% 56% 51% 49% 48% 45% 36% 69% For many institutions, ETFs also have taken on a central role in the critical functions of risk and liquidity management. Nearly half the ETFs are the cheapest institutions in the study use ETFs for liquidity management, and close and most efficient way to the same share employ ETFs in risk management/overlay strategies. to implement active strategies. In explaining why her fund uses ETFs so widely in its portfolio, the CEO, U.S. ASSET Finance Director of a U.S. foundation sums up the comments of many MANAGEMENT FIRM of her institutional peers: ETFs provide us with another bullet. 4 GREENWICH ASSOCIATES

5 ETFs Are Efficient Long- and Short-Term Exposure Vehicles Although study participants view ETFs primarily as a vehicle for obtaining strategic investment exposures and otherwise implementing their investment strategies, institutions are stepping up their use of the funds in rapid, tactical applications likely in response to or in preparation for a more volatile environment ahead. Institutional ETF users in the study categorize two-thirds of their ETF holdings as strategic in nature. Data on holding periods backs up that description. Seventy percent of institutional ETF investors report average ETF holding periods of one year or longer, the general threshold for assets considered strategic. In fact, nearly half of these institutions report average holding periods of two years or more. 68 % OF INSTITUTIONAL ETF HOLDINGS ARE STRATEGIC IN NATURE The consensus that ETFs are primarily a strategic tool is a relatively recent development in the U.S. institutional market. Many U.S. institutions started using ETFs first for tactical purposes. Institutional funds often made their initial ETF investments as part of a manager transition. Others started using the funds to gain quick and temporary equity exposure for cash holdings or to make other tactical adjustments to their portfolios. Once institutions had introduced ETFs to their portfolios, they quickly realized that the funds can actually provide an efficient and effective means of obtaining investment exposures including the core strategic exposures upon which they built their investment strategies. Institutions increasing reliance on ETFs to implement active allocation decisions is demonstrated in another interesting finding. Eighty-seven percent of institutions in the study think equities will be the best performing asset class in 2017, with 49% naming developed market equities and 38% citing emerging market equities. Forty-four percent of the institutions say they will use ETFs to implement that asset allocation view, topping active mutual funds (29%), individual stocks and bonds (18%) and all other investment vehicles. To some extent, the relatively large share of these institutions planning to use ETFs to obtain equity exposures reflects investors growing skepticism about the ability of active investment managers to reliably deliver alpha in large and liquid markets. We believe in ETFs because active managers have not consistently outperformed the indexes and ETFs are a low-cost way of diversifying, says the Executive Director of a U.S. university endowment. An investment analyst for a U.S. asset manager agrees: As cost pressures increased, we have replaced low-conviction active funds with ETFs. 5 GREENWICH ASSOCIATES

6 ETF Trading Advantages Seen as Top Benefits Institutional investors cite three primary reasons for using the funds: liquidity, ease of use and quick market access. These trading-oriented factors are consistent across equities and fixed income. ETFs are a liquid vehicle we know we can move in large size, says a study participant representing a large U.S. asset manager. With ETFs, we are able to put money to work instantly, says one U.S. RIA. KEY ADVANTAGES OF ETFs The beauty is [ETFs ] liquidity allows you to equitize your cash, mitigating cash-drag. You can also source that cash in order to rebalance. U.S. HEDGE FUND REPRESENTATIVE Liquidity 85% Bond 1 Equity 2 Liquidity 85% Easy to use 79% Easy to use 83% Quick access 78% Market access 77% Single-trade diversification 73% Attractive management fee 77% Lower trading costs versus cash bonds 71% Speed of execution to gain diversified exposure 74% Low management fees 66% Single-trade diversification 73% Avoid need for single security analysis 63% Lower trading costs versus individual stocks 63% Note: 1 Based on 103 responses. 2 Based on 137 responses. Source: Greenwich Associates 2016 U.S. Exchange-Traded Funds Study In equities, among institutions that invest in ETFs, 85% name liquidity and 83% ease of use as important reasons for doing so, making these factors the top drivers of equity ETF use. One investment professional from a U.S. asset manager says his firm uses ETFs specifically because they have better intra-day liquidity than individual stocks. In fixed income, 85% name liquidity as an important reason for using ETFs, and nearly 80% each cite ease of use and quick access. The representative of a U.S. hedge fund says he most values ETF liquidity and capacity. The beauty is their liquidity allows you to equitize your cash, mitigating cash-drag. You can also source that cash in order to rebalance, he says. An executive vice president of a large U.S. institutional fund summed up the benefits his organization derives from the funds: ETFs allow us to keep costs down relative to competition and make asset allocation more precise and highly liquid. 6 GREENWICH ASSOCIATES

7 ETFs as a New Class of Financial Instrument Over the past five years, the lion s share of new ETF assets have migrated from single securities and funds. Among the 4 in 10 institutions noting that ETFs have displaced other investment vehicles, 71% mention active mutual funds, followed by index mutual funds, and individual stocks and bonds. PRODUCTS OR INVESTMENT VEHICLES REPLACED BY ETFs Active mutual funds Index mutual funds 43% 71% Institutions are also using ETFs alongside derivatives for index exposure. About 30% use futures and total return swaps, and smaller shares use credit default swaps and options. Among these derivative users, 52% replaced an existing derivative position with an ETF in the past year. More than 40% say they made the switch for operational simplicity and 19% for regulatory reasons. A smaller share of respondents did so for reasons of rolling costs, securities lending, funding costs, and leverage limits. Investment consultants are recommending that their clients consider ETFs as alternatives to other investment vehicles. One U.S. investment consultant points out that clients sometimes have restrictions against using derivatives to gain beta exposures. In those cases, ETFs can serve the purpose. Another consultant says he is recommending ETFs to clients due to the increasing complexity of futures positions versus the simplicity of ETFs. Individual stocks Individual bonds SMA/UMA Institutional separate/ managed accounts Common Trust Funds (CTFs)/Commingled Trust Fund 8% 20% 18% Note: Based on 49 responses. Source: Greenwich Associates 2016 U.S. Exchange-Traded Funds Study 41% 37% Looking ahead, one-third of the institutional ETF users in the study plan to replace an existing equity futures position with ETFs. About 20% plan to replace a fixed-income futures position with an ETF. A much larger share 43% say they will be actively evaluating futures positions in both asset classes for possible replacement with ETFs, a significant increase from the 22% planning to do so in One-third of institutions planning to make such a change say they are doing so to improve performance in the areas of liquidity and efficiency of exposure. About a quarter plan to USING ETFs ALONGSIDE DERIVATIVES % have replaced a derivative product with an ETF 52% have replaced a derivative product with an ETF Operational simplicity Regulations Rolling costs 14% 19% 43% Securities lending 10% Reasons for Shift to ETFs Note: Based on 23 responses in 2015 and 21 in 2016 from institutional investors who use futures to access beta. Source: Greenwich Associates 2016 U.S. Exchange-Traded Funds Study 7 GREENWICH ASSOCIATES

8 make this switch in order to reduce costs, and smaller shares say they will make the move to improve risk management or for operational simplicity and ease of use. EVALUATING FUTURES POSITIONS FOR REPLACEMENT WITH ETFs As ETFs have become commonplace in institutional portfolios, they have evolved from a valuable complement to mutual funds to an alternative to derivatives like a stand-alone financial instrument with unique benefits of their own. ETFs are viewed as flexible tools enabling institutions to achieve a wide range of strategic and tactical portfolio applications. 22% 43% Using Smart Beta to Address Key Challenges Many institutions planning to increase their allocations to ETFs said they were doing so to take advantage of growth in the ETF product mix and the availability of new fund types in smart beta ETFs. Growing numbers of institutions are turning to innovative ETF structures to help navigate the challenges posed by low interest rates and increasing market volatility. The share of institutional ETF users investing in smart beta ETFs increased to 37% in 2016 from 31% in Forty-one percent of asset managers and 52% of RIAs invest in these funds, and half of investment consultants say their clients use them. GROWING USE OF SMART BETA ETFs 37% 31% The two most popular fund types in this category are minimum-volatility ETFs and dividend/equity-income ETFs. Nearly two-thirds of institutions using smart beta ETFs employ each of these fund types Note: Based on 118 responses in 2015 and 148 in Source: Greenwich Associates 2016 U.S. Exchange-Traded Funds Study MOST WIDELY USED SMART BETA ETFs Minimum-volatility ETFs Dividend/Equity-income ETFs 65% 64% Multi-factor ETFs Single factor ETFs 53% 53% Equal-weighted ETFs 44% Sector smart beta Environmental, social and corporate governance (ESG) Smart beta commodities Smart beta fixed income 20% 13% 11% 7% Note: Based on 55 responses. Source: Greenwich Associates 2016 U.S. Exchange-Traded Funds Study 8 GREENWICH ASSOCIATES

9 The strong demand for these funds is reflective of the challenges facing institutional investors today, including the need for yield and concerns about increased market volatility in the current rate environment. Institutional demand has either increased or held steady for a variety of other fund types, including multi-factor and single-factor ETFs, equalweighted ETFs, sector smart beta ETFs, and others. Forty-four percent of institutions currently investing in smart beta ETFs plan to increase their allocations to the funds in the next year. Only 7% plan cuts. Three-quarters of these institutions plan to boost allocations by at least 5%, and 38% expect increases in excess of 10%. Demand is projected to increase for multi-factor ETFs, with about 45% of institutions planning increases expecting to target these fund types for investment. Between 35% and 40% of these institutions anticipate increasing allocations to each of equal-weighted ETFs and min-vol ETFs. Finally, the growth in smart beta seems to be driven by a shift in the way investors are managing their portfolios. Only a third of U.S. institutions in the study have explicit allocation targets to passive and active strategies. Another 12% of the institutions monitor and target active and beta components primarily within each active exposure, and 22% do so across their entire portfolio. Continued evolution of portfolio management philosophies that depart from the traditional active/passive framework should lead to additional increases in demand for smart beta ETFs. More Growth Ahead PLANS FOR INCREASING SMART BETA ETF ALLOCATIONS Plan to Increase 1 Plan to decrease 7% Remain same 44% plan to increase 48% smart-beta allocations 1 Expected Increase in Smart Beta Usage 2 25% 1 4% 38% 38% 5 10% >10% Note: May not total 100% due to rounding 1 Based on 54 responses. 2 Based on 24 responses. Source: Greenwich Associates 2016 U.S. Exchange-Traded Funds Study Institutions that invest in ETFs are allocating a growing share of assets to the funds. The increase in ETF allocations is most pronounced among asset managers, which are increasingly managing multi-asset strategies, which sometimes hold very large allocations to ETFs. In fact, 10 of the asset managers included in the study had average ETF allocations above 50%. Overall, institutional ETF users invest an average 21% of total assets in the funds up from the 19% of total assets reported in At nearly 35%, allocations are by far the largest among asset managers. That share is up sharply from the 29% average reported by asset managers last year an increase likely attributable to the proliferation of multi-asset strategies. RIAs report ETF allocations of approximately a quarter of total assets. Across all types of ETF investors, about 12% of institutions allocate more than half of total assets to the funds. Institutions that use equity ETFs invest an average of over 30% of total equity assets in the funds, up from the 23% average allocations reported in Again, these averages are inflated by the 39% of total equity assets invested in ETFs by the asset managers we spoke with, several of whom manage portfolios comprised entirely of ETFs, including many managing multi-asset funds. 9 GREENWICH ASSOCIATES

10 ETFs A GROWING PROPORTION OF PORTFOLIOS Total Asset Managers >20% 31% 23% 37% 49% 1 20% 68% 77% 51% 63% Note: Based on 143 total responents, 39 asset managers in 2016 and 112 total respondents, 24 asset managers in May not total 100% due to rounding. Source: Greenwich Associates 2016 U.S. Exchange-Traded Funds Study Institutions that use bond ETFs invest an average 21% of total fixedincome assets in the funds. Average allocations, again, are largest among asset managers at 39% and RIAs at close to 22%. Bond ETF Use Rising Meanwhile, the share of institutional ETF users investing in bond ETFs continues to climb. Of U.S. institutions that currently use ETFs, 71% now invest in bond ETFs, up from about two-thirds in Usage is heaviest in domestic fixed income, including investment grade, high yield, treasuries, and municipals, but about a quarter of ETF users employ bond ETFs in international fixed income. Forty-seven percent of equity ETF investors expect to increase their allocations to the funds in the year ahead, with only 2% projecting a decrease. Increases should be most widespread among insurance companies, 53% of which are planning to expand allocations. Across all types of institutions, increases in allocations could be substantial: over two-thirds of the institutions planning increases expect to boost allocations by at least 5%, and approximately a third are planning increases in excess of 10%. EXPECTED CHANGE IN ALLOCATIONS TO ETFs IN NEXT 12 MONTHS Decrease Increase Equity ETFs 5% 2% 36% 47% Fixed-Income ETFs % 8% 35% 38% Note: Based on 111 responses for equity ETFs and 84 for fixed-income in 2015, and 131 responses for equity ETFs and 94 for fixed-income in Source: Greenwich Associates 2016 U.S. Exchange-Traded Funds Study 10 GREENWICH ASSOCIATES

11 ETF USE BY ASSET CLASS % Using ETFs for Equity Exposure 95% 97% % Using ETFs for Fixed-Income Exposure 65% 71% % Using ETFs for Other Exposures 55% 65% Domestic equity International developed equity International emerging markets equity International developed ex-u.s. equity European equity 86% 76% 67% 66% 50% Domestic investment grade Domestic high yield Domestic government bonds U.S. municipal bonds International investment grade 49% 46% 44% 24% 24% REITs Commodities Cash and cash equivalents Precious metals Hedge funds 48% 44% 25% 1% 1% Asian equity 38% International government bonds 24% Currency 1% International credit 19% Mortgage-backed securities 16% International high yield 13% Asset-backed securities 11% Note: Based on 119 responses in 2015 and 147 in Source: Greenwich Associates 2016 U.S. Exchange-Traded Funds Study Thirty-eight percent of current investors in bond ETFs expect to increase their allocations to the funds in the next year. That share includes 53% of asset managers. Three-quarters of these institutions plan to increase allocations by at least 5%, and approximately 30% expect to boost allocations by 10% or more. Seventeen percent of institutions in the study not currently using fixed-income ETFs say they are at least somewhat likely to start investing in the funds in the next year. ETF growth rates could accelerate in coming months if the rates environment shifts and macroeconomic and political developments lead to increases in volatility. Persistent concerns about liquidity levels in fixed income will also continue to attract institutions to ETFs. As a representative of a U.S. asset management firm puts plainly, We expect rates are going up and it s easier to trade ETFs. 11 GREENWICH ASSOCIATES

12 THE MULTI-ASSET BOOM ETFs are attracting new investments from asset managers launching products to meet growing demand among their clients for multi-asset funds. ETFs make it easier to create and manage multi-asset funds and complete portfolios without the need for in-house security selection across all asset classes. Fifty-two percent of asset management ETF investors use ETFs in discretionary portfolios or multi-asset funds. That share is up sharply from the 35% reported in 2015, reflecting the surge in popularity for multiasset funds from investors of all types both in the U.S. and around the world. ETFs have increased over the past 10 years from 50% to 90% of our strategy, says a multi-asset portfolio manager of a U.S. asset management firm. We have a very global asset allocation framework, and ETFs are perfect tools to provide the asset class exposure that we need. INCREASING USE OF ETFs BY MULTI-ASSET PORTFOLIO MANAGERS 52% 35% We use ETFs to gain exposure to countries prior to registration (e.g., India). They are excellent tactical tools to gain the exposure we want. MULTI-ASSET PORTFOLIO MANAGER Note: Based on 26 asset managers in 2015 and 33 in Source: Greenwich Associates 2016 U.S. Exchange-Traded Funds Study Impediments to ETF Use Continue to Dissipate Barriers that prevented institutions from investing in ETFs in the past continue to give way especially in fixed income. Among non-users participating in the 2016 study, 32% say concerns about low trading volumes or assets keep them from investing in bond ETFs, making that the single biggest impediment to use. However, given the fact that so many institutions are expanding their use of bond ETFs specifically to access liquidity benefits provided by the funds, Greenwich Associates expects these worries to lessen in coming months especially if investors continue to experience shortages of liquidity in individual bonds. A similar process appears already to be unfolding among institutions that don t invest in bond ETFs due to concerns about the misalignment of the constant maturity profile of many funds with the declining maturity of bonds. In 2015 almost 30% of non-users cited that as a reason for not using bond ETFs; in 2016 that share dropped to 19%. 12 GREENWICH ASSOCIATES

13 At the same time, explicit prohibitions or limitations against ETF investments are falling by the wayside in both equities and fixed income. In 2015, nearly a quarter of non-users said they were prevented from investing in bond ETFs by internal investment guideline restrictions. That share fell to 19% in In equities, the share of institutions citing internal guideline restrictions as a reason for decreasing or not expanding their ETF allocations dropped to 9% from 20%. Greenwich Associates sees these declines as part of a natural progression in which institutions gradually lessen and eventually remove rules prohibiting or limiting ETF usage, after seeing their peers employing ETFs safely and effectively. Regulators likely will follow a similar course, providing new opportunities for the 17% of non-users now prevented from investing in bond ETFs by regulatory restrictions, and for the nearly 1 in 10 equity ETF investors who say regulations are causing them to reduce or refrain from expanding equity ETF allocations. Also pointing in the direction of expanding ETF use is the fact that fewer institutions say they are avoiding ETFs due to expenses. Almost a quarter of institutions who in 2015 said they were cutting allocations to equity ETFs said expenses were driving that decision. That share dropped to 9% in Meanwhile, a growing share of institutions planning to increase equity ETF allocations say they are doing so to reduce expenses. In fixed income, nearly a quarter of non-users cited expenses as a reason for not investing in bond ETFs in In 2016 that share dropped to just 11%. Meanwhile, 22% of ETF investors that are planning to increase allocations to bond ETFs say they are doing so because the funds are lower cost or cost-effective. [Our decision to increase bond ETF allocations in natural shift. Our corporate thinking has shifted with the help of the providers. RIA the coming year] is a All of these findings demonstrate that the ETF institutional market is maturing. This process will continue to unfold as ETFs are adopted by more institutions for more applications. Providers can accelerate this process by maintaining or even expanding successful programs to educate portfolio managers and institutional investment committees about the traits and benefits of ETFs. One RIA explains the impact these efforts have had on his firm s decision to increase its use of fixed-income ETFs in the next year. It s a natural shift, he says. Our corporate thinking has shifted with the help of providers. 13 GREENWICH ASSOCIATES

14 ishares/blackrock IS TOP U.S. ETF PROVIDER When conducting due diligence on a potential ETF investment, institutions consider four primary factors: the degree to which the ETF matches their exposure needs, liquidity/trading volume, the expense ratio of the fund, and performance/tracking error. Insurance companies, of course, pay close attention to an ETF s NAIC rating, and institutions across the board also take into account the fund company and management behind the ETF. Based largely on its performance in these key areas, ishares/blackrock retained its position as the ETF provider of choice for U.S. institutions in Ninety-nine percent of U.S. institutional ETF investors in the study use ishares/blackrock as a provider. Sixty-eight percent use State Street/SPDRs, approximately two-thirds use Vanguard and 48% use PowerShares. MOST FREQUENTLY USED ETF PROVIDERS ishares/blackrock State Street/SPDRs Vanguard PowerShares 68% 64% 63% 48% 45% 32% 99% 94% 87% 65% 73% 68% The institutions participating in Greenwich Associates 2016 U.S. ETF Study name ishares/blackrock as the top provider in a range of critical categories including product liquidity, range of products, exposures and domiciles, index tracking, servicing platform, innovation and transparency. Vanguard is ranked highest for providing good value for the management fees. ETF DECISION-MAKING CRITERIA WisdomTree PIMCO Van Eck 35% 17% 0% 18% 18% 22% 16% 13% 15% Matches exposure needs Liquidity/Trading volume 71% 65% Deutsche X-trackers/ db X-trackers 14% 18% 0% Expense ratio of fund Performance of fund (tracking error/ tracking difference) NAIC rating Fund company and management behind the funds Benchmark used/benchmark provider Where ETF is domiciled (U.S., UCITS, my local jurisdiction) 47% 43% 39% 31% 62% 60% First Trust % 5% 0% Note: Based on 141 responses in 2016, 120 in 2015 and 201 in Source: Greenwich Associates 2016 U.S. Exchange-Traded Funds Study Assets under management of ETFs 29% Quality of service offered by fund provider 23% Breadth of ETF offerings 17% Note: Based on 149 responses. Source: Greenwich Associates 2016 U.S. Exchange-Traded Funds Study 14 GREENWICH ASSOCIATES

15 Conclusion U.S. institutions are using ETFs as a multi-purpose tool. Due to the sheer versatility of the funds, institutional investors are integrating ETFs into nearly every aspect of their portfolio across asset classes and into critical functions like risk, volatility and liquidity management. The proliferation of new smart beta fund structures that help institutions address myriad challenges is fueling new investment. Demand is also growing for multi-asset funds, in which ETFs are playing an increasingly important role. As these trends unfold, institutions are integrating ETFs deeper into their portfolios as complements to individual securities, mutual funds, options, and futures. Over time, ETFs are likely to become as common in these portfolios as these other established investment vehicles. Cover Illustration: istockphoto/alice-photo The data reported in this document reflect solely the views reported to Greenwich Associates by the research participants. Interviewees may be asked about their use of and demand for financial products and services and about investment practices in relevant financial markets. Greenwich Associates compiles the data received, conducts statistical analysis and reviews for presentation purposes in order to produce the final results. Unless otherwise indicated, any opinions or market observations made are strictly our own Greenwich Associates, LLC. Javelin Strategy & Research is a division of Greenwich Associates. All rights reserved. No portion of these materials may be copied, reproduced, distributed or transmitted, electronically or otherwise, to external parties or publicly without the permission of Greenwich Associates, LLC. Greenwich Associates, Competitive Challenges, Greenwich Quality Index, Greenwich ACCESS, Greenwich AIM and Greenwich Reports are registered marks of Greenwich Associates, LLC. Greenwich Associates may also have rights in certain other marks used in these materials. greenwich.com ContactUs@greenwich.com Ph Doc ID

16 Reprinted with permission of Greenwich Associates, LLC, February The opinions expressed in this reprint are intended to provide insight or education and are not intended as individual investment advice. Carefully consider the ishares Funds investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds prospectuses or, if available, the summary prospectuses which may be obtained by visiting or Read the prospectus carefully before investing. Investing involves risk, including possible loss of principal. Transactions in shares of ETFs will result in brokerage commissions and will generate tax consequences. There can be no assurance that an active trading market for shares of an ETF will develop or be maintained. Shares of the ishares Funds may be sold throughout the day on the exchange through any brokerage account. However, shares may only be redeemed directly from a Fund by Authorized Participants, in very large creation/ redemption units. The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective. This study was sponsored by BlackRock. The ishares Funds are distributed by BlackRock Investments, LLC (together with its affiliates, BlackRock ). BlackRock is not affiliated with Greenwich Associates, LLC, or its affiliates. The ishares Funds that are registered with the U.S. Securities and Exchange Commission under the Investment Company Act of 1940 are distributed in the U.S. by BlackRock Investments, LLC (together with its affiliates, BlackRock ). This material does not constitute an offer or solicitation to sell or a solicitation of an offer to buy any shares of any Fund (nor shall any such shares be offered or sold to any person) in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities law of that jurisdiction. ishares and BLACKROCK are registered trademarks of BlackRock. All other marks are the property of their respective owners. is

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