GREENWICH ASSOCIATES. European Insurance Companies Find Many Uses for ETFs

GREENWICH ASSOCIATES European Insurance Companies Find Many Uses for ETFs

CONTENTS Executive Summary 3 From Tactical to Strategic 3 Potential for Growth 4 An Efficient Tool for Equities 4 Fixed Income and Beyond 5 Selection Criteria 6 GRAPHICS Primary ETF Applications in Insurance Companies Institutional Portfolios 4 Most Institutional Users Allocate 1 10% of Total Assets to ETFs 4 Reasons Insurance Companies Use Equity ETFs 5 Asset Class Use 5 Reasons Insurance Companies Use Fixed-Income ETFs 6 Top 3 Most Important Factors for Insurance Companies When Selecting an ETF 6 METHODOLOGY Greenwich Associates interviewed a total of 120 European-based institutional investors, 83 of which were exchange-traded fund users and 37 were non-users, in an effort to track usage behaviors and examine perceptions associated with exchangetraded funds. The respondent base consisted of 68 pension funds (corporate and public funds, and other institutional investors), 30 asset managers (firms managing assets to specific investment strategies/guidelines) and 22 insurance companies. Insurance companies Asset managers 25% 18% Respondents 57% Pension funds Cover Photos istockphoto.com/zentilia and istockphoto.com/timarbaev 2014 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.

Executive Summary European insurance companies are adopting ETFs for a wide range of functions across their investment operations. Approximately one-quarter of large, continental-european insurance companies now use ETFs, and Greenwich Associates research projects that share to grow in the next 12 months. Insurers in both continental Europe and the United Kingdom are using ETFs in surplus, reserve and proprietary investment portfolios, as well as in annuities and other investment products. Although the most common use of ETFs is in making tactical adjustments to portfolios, a majority of insurance companies also use ETFs for critical strategic actions such as diversifying portfolios and obtaining core investment strategies. ETF use is most widespread in equities, where a move to diversify portfolios internationally is boosting use. A growing number of insurance companies are also using ETFs in fixed income and in other asset classes such as commodities. Greenwich Associates projects that ETF usage rates and portfolio allocations will increase in coming years as insurance companies discover additional benefits and efficiencies, and internal investment guidelines are loosened to accommodate more diverse portfolio holdings and strategies. ETFs are taking on a growing role in the investment operations of European insurance companies as insurers apply the funds in a range of functions spanning surplus assets, reserve assets, investment products, and in the management of their own assets. About one-quarter of large European insurance companies use ETFs, according to the results of Greenwich Associates 2014 Continental European Investment Management Study. That share is poised to grow, since about 25% of the insurance companies not currently using ETFs said they plan to start using the funds in the next 12 months. In light of the increasing popularity of ETFs among institutional investors, Greenwich Associates conducted a special study examining why and how European institutions are employing the funds in their investment portfolios. As part of that study, the firm interviewed 21 large insurance companies in continental Europe and the United Kingdom that have adopted ETFs. The results of that research show that ETFs are proliferating among insurers, due in large part to flexibility that makes the funds useful across many facets of insurance company operations. Roughly two-thirds of the insurance companies in the study hold ETFs directly on their balance sheets, with the remainder investing in ETFs via external asset managers. (About half the insurers manage 100% of assets internally.) Approximately 70% of the funds say the ETFs now in their portfolios have replaced other investment vehicles, such as actively managed investment products that have failed to outperform benchmarks or otherwise deliver adequate value. These ETFs are performing a variety of functions: Fifty-eight percent of the European insurance companies in the study use ETFs to achieve revenue targets in surplus asset investing. Forty-two percent of the insurers use ETFs to invest their own assets. About one-third of the insurers use ETFs to match liabilities in reserve assets a share that easily tops the 25% of U.S. insurance companies that reported using ETFs in reserve assets in 2014. Forty-two percent of the insurance companies use ETFs in unit-linked products. One-quarter of the insurers use ETFs in annuities. From Tactical to Strategic That list demonstrates the diversity of uses insurance companies have found for ETFs, ranging from narrow, tactical portfolio operations to broad, strategic applications. Fifty-seven percent of the insurance companies in the study describe their use of ETFs as mainly tactical in nature. In fact, Greenwich Associates research among institutional investors in Europe, the United States and Canada shows that institutions often first introduce ETFs into their portfolios for specific tactical tasks before, over time, discovering their value for more strategic functions. GREENWICH REPORT 3

Primary ETF Applications in Insurance Companies Institutional Portfolios Most Institutional Users Allocate 1 10% of Total Assets to ETFs International diversification Tactical adjustments Core allocation Liquidity management 29% 57% 62% 62% Insurance companies Asset managers Pension funds 11% 89% 4% 8% 4%4% 79% 17% 62% 21% Rebalancing 21% Risk management 14% 0% 1 10% 11 25% 26 75% 76 100% Cash equitization Overlay management Transition management Other Interim beta 5% 14% 14% 10% 0% Note: Based on responses from 21 insurance companies in 2014. Source: Greenwich Associates 2014 European Exchange-Traded Funds Study Among the insurers, 62% report using ETFs for making just these types of tactical adjustments to their portfolios. However, the study results show that the majority of insurers have recognized ETFs strategic potential, with 62% using ETFs to achieve international diversification and 57% using the funds to obtain desired exposures in the core components of their investment portfolios. Potential for Growth To achieve these varied goals, the insurance companies are allocating 1 10% of total assets to ETFs. Greenwich Associates expects those allocations to increase over time. One-third of the insurancecompany ETF users in the study plan to increase their allocations to ETFs in the next three years. (Only 18% expect to decrease ETF allocations, with the remainder planning to maintain current allocations.) The insurance companies in the study gave the following reasons for using ETFs: ETFs enable us to get quick exposures. When we wish to increase a position, we temporarily use ETFs. Note: Based on 71 responses: 29 pension funds, 24 asset managers and 18 insurance companies. Source: Greenwich Associates 2014 European Exchange-Traded Funds Study ETFs are an efficient way to obtain beta. Flexibility and liquidity. ETFs are simple to use. For the lower commissions. They are reasonably priced and transparent. ETFs are flexible instruments that allow for diversification at a lower cost. An Efficient Tool for Equities Most institutional investors started using ETFs in equities, and the study results suggest that European insurers are no exception. Fifty-seven percent of the insurance companies use ETFs in domestic equities and three-quarters use ETFs in international equities. That robust level of usage in international equities mirrors a pattern seen throughout the institutional market in Europe. Among pension funds, asset managers and other institutions, efforts to diversify investment portfolios beyond the domestic assets that have traditionally dominated their holdings are pushing institutions beyond the capabilities and expertise of internal investment resources. As they move assets into unfamiliar foreign markets, insurance companies and other institutions are finding ETFs to be an efficient way of taking on desired exposures. As one insurance company representative said, We use ETFs to invest in markets where we don t have analyst coverage. GREENWICH REPORT 4

Reasons Insurance Companies Use Equity ETFs Speed of execution to gain diversified exposure Single-trade diversification Easy to use Market access Liquidity Lower trading costs Avoid need for single security analysis 36% 36% 36% 50% 54% 64% 71% Note: Based on responses from 14 insurance companies in 2014. Source: Greenwich Associates 2014 European Exchange-Traded Funds Study years to come. About one-third of the insurance companies use ETFs in domestic fixed income, and a similar share use ETFs in international fixed income. Several study participants said they use fixed-income ETFs mainly for the funds ability to efficiently deliver passive exposures. On average, the insurance companies in the study have slightly more than a quarter (26%) of their fixed-income assets invested in passive strategies. Overall, the insurance companies cited several primary benefits to bond ETFs, including single-trade diversification, ease of use, liquidity and quick access. When asked to name the factors that might limit or even prohibit their use of fixed-income ETFs, insurance companies cited internal investment guidelines and limits, a lack of understanding of how ETFs work, and perceptions of low trading volume. There is significant room for growth in domestic equities. Although many European institutions are now investing sizable shares of their portfolios in passive strategies, most (72%) of the insurance companies in the study allocate 10% or less of total assets to ETFs. Thirty-six percent of the insurance companies plan to increase these allocations to equity ETFs in the next three years. Among the most important benefits cited by these insurers are equity ETFs speed of execution in gaining diversified exposures, single-trade diversification and access to difficult-to-invest-in markets. Fifty-seven percent of the insurers in the study plan to keep ETF allocations steady over the next three years. One factor holding back institutions from expanding their allocations are internal guidelines or limits. However, Greenwich Associates expects many institutional investors to loosen internal investment restrictions and guidelines in coming years in order to facilitate the much-needed diversification of investment portfolios. Such a move could remove internal restraints and open the door to more widespread use of ETFs. Asset Class Use Domestic equities International equities Domestic fixed income International fixed income Commodities Property/REITs Other 0% 0% 3% 15% 18% 14% 24% 30% 27% 24% 33% 33% 33% 69% 57% 88% 83% 76% 52% 59% 45% Fixed Income and Beyond Although 90% of the insurance companies using ETFs in fixed income have been doing so for two years or more, fixed income and other new asset classes could be the areas of biggest growth in the Pension fund Asset manager Insurance Note: Based on 83 responses: 33 pension funds, 29 asset managers and 21 insurance companies. Source: Greenwich Associates 2014 European Exchange-Traded Funds Study GREENWICH REPORT 5

Reasons Insurance Companies Use Fixed-Income ETFs Top 3 Most Important Factors for Insurance Companies When Selecting an ETF Single-trade diversification 75% Liquidity/Trading volume 62% Easy to use 63% Expense ratio of fund Benchmark used 43% 57% Quick access 63% Performance of fund 42% Liquidity 63% Assets under management of ETFs 29% Avoid need for single security analysis Lower trading costs vs. cash bonds 25% 50% Note: Based on responses from 8 insurance companies in 2014. Source: Greenwich Associates 2014 European Exchange-Traded Funds Study Structure of the ETF Matches exposure needs Quality of service offered by fund provider Breadth of ETF offerings Fund of company and management behind funds 0% Cost structure 0% 5% 10% 10% 19% Given concerns about liquidity levels in corporate bond markets, Greenwich Associates believes that worries about ETF liquidity will not represent a major impediment to ETF growth. As in equities, Greenwich Associates expects internal constraints on ETFs and other investments to gradually give way as European institutions seek out new strategies and products required to achieve needed investment returns in an increasingly challenging market environment. Finally, stepped up efforts on the part of ETF providers to educate institutions about the benefits of the funds will help overcome the hesitancy among some insurers to experiment with an unfamiliar investment vehicle. All of these signs point to continued growth in the use of fixed-income ETFs. Indeed, 63% of the insurance companies now using fixed-income ETFs expect to increase their allocations over the next three years. Meanwhile, about a quarter of institutions are using ETFs in commodities. Usage of ETFs in fixed income and commodities has climbed to higher levels among other types of institutions in Europe. For example, about half the European asset managers participating in the study now employ ETFs in domestic fixed income, and approximately 60% use the funds in international fixed income. Forty-five percent of the asset managers use ETFs in commodities. These 0% 10% 20% 30% 40% 50% 60% Note: Based on 21 responses from insurance companies in 2014. Source: Greenwich Associates 2014 European Exchange-Traded Funds Study sizable and growing shares show that institutional investors are finding ETFs to be useful means of acquiring desired investment exposures in these new asset classes. Selection Criteria When European insurance companies are seeking out specific ETF investments, they focus on four main criteria: liquidity/trading volume, total expense ratio, the benchmark used by individual ETFs, and past fund performance (including tracking effort). Based largely on these selection criteria, European insurance companies have made BlackRock their ETF provider of choice. The insurers in the study rank BlackRock as Best-in-Class in a wide range of categories including Product Liquidity, Good Value for Management Fees, Strong Index Tracking, Innovation, Product Range, and Exceptional Service. GREENWICH REPORT 6

Consultant Lydia Vitalis is responsible for managing relationships with a number of leading asset managers and investment consultants globally, and oversees the Firm s work with investors across Europe. 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 REPORT 7

Reprinted with permission of Greenwich Associates, LLC, December 2014. The strategies discussed are strictly for illustrative and educational purposes and should not be construed as a recommendation to purchase or sell any security. There is no guarantee that any strategies discussed will be effective. The information provided is not intended to be a complete analysis of every material fact respecting any strategy. The examples presented do not take into consideration commissions, tax implications or other transactions costs, which may significantly affect the economic consequences of a given strategy. Transactions in shares of ETFs will result in brokerage commissions and will generate tax consequences. All regulated investment companies are obliged to distribute portfolio gains to shareholders. In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Narrowly focused investments typically exhibit higher volatility. Bonds and bond funds will decrease in value as interest rates rise and are subject to credit risk, which refers to the possibility that the debt issuers may not be able to make principal and interest payments or may have their debt downgraded by ratings agencies. Diversification and asset allocation may not protect against market risk or loss of principal. Shares of ETFs 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. There can be no assurance that an active trading market for shares of an ETF will develop or be maintained. This study was sponsored by BlackRock. ishares and BLACKROCK are registered trademarks of BlackRock. All other marks are the property of their respective owners. is-12443-0514 GREENWICH ASSOCIATES www.greenwich.com 6 High Ridge Park Stamford CT 06905 USA Ph +1 203.625.5038/+1 800.704.1027 ContactUs@greenwich.com