Institutional investors expect to increase allocations to exchange-traded funds (ETFs). Myriad factors, including reduced cost, are driving usage of the vehicle, according to The Cerulli Report—North American Institutional Markets 2024.

Calculated as the percentage of investors that expect to increase allocations less the percentage of investors that expect to decrease allocations, Cerulli’s research finds that a net 37% of institutions expect to increase allocations to ETFs in the next two years, while a net 11% expect to decrease allocations to mutual funds. Among institutional channels, this trend is most notable among insurance general accounts—a net 40% expect to increase allocations to ETFs while a net 25% expect to decrease allocations to mutual funds. Given that the two vehicles are similar in the way they are structured, it can be reasoned that part of the impetus driving these expected flows is the overarching trend of cost reduction.

A deeper analysis into how institutions are using ETFs shows that cost-cutting may not be the sole, or even primary, driver. ETFs are already widely adopted across institutions—80% of institutional investors surveyed by Cerulli report using ETFs—but only 16% of institutions that use ETFs say they use the vehicle as a core portfolio holding. Far more often, they use ETFs to gain or maintain exposures (51%), manage cash/liquidity (34%), and/or make tactical bets (27%).

“The most common use cases for ETFs suggest that institutions are not holding their positions for an extended period, as they would for other mandates,” says Jack Tamposi, associate director. “Institutions indicate that they use the vehicle as a transition tool, managing exposures to asset classes, rather than as a long-term, core investment holding.”

While institutional investors predominantly use passively managed equity ETFs, the use of other strategy types has become much more common. According to Cerulli, at least 76% of institutional investors across channels employ passive equity ETFs. Insurance companies, which have the highest rate of adoption across all ETF types, use active equity and passive fixed-income ETFs at the same rate (78%). Active fixed-income ETFs are used the least frequently across institutions; insurance companies use this type of product the most (67%), and foundations use them at a much lower clip (35%). In the fixed-income ETF space, specifically, a lack of funds with established track records and accumulated assets has likely hampered the appetite from institutional investors.

Although the use cases for ETFs remain varied, Cerulli has observed wider adoption and an increased prevalence of institutions using the vehicle as a long-term holding. “As ETFs become more common in the institutional space, and as institutions continue to look for ways to reduce costs in their traditional investment portfolios in favor of allocating their risk budgets toward esoteric strategies (e.g., private markets), Cerulli expects more institutions will use ETFs as long-term holdings,” says Tamposi. “As asset managers seek to win more mandates, it is important to look at not only the types of strategies that will be in vogue, but also the types of vehicles that will allow institutions to pursue these strategies,” he concludes.