Institutional investors will broaden their ETF applications in 2013, predicted BlackRock’s iShares group.

The company singled out three trends for ETFs this year:

More active manager and advisor ETF portfolios

Active managers will likely continue to use ETFs for asset allocation in an effort to achieve alpha in balanced funds, asset allocation funds, defined contribution plans, and annuities. Among global asset managers, use of ETFs grew from $105 billion in the third quarter of 2011 to $125 billion in 2012's third quarter.

Active managers and hedge funds mainly use ETFs for global asset allocation portfolios. They often turn to country and sector ETFs for cash “equitization” (transforming low-yielding cash into a portfolio asset). The iShares report also sees growth for advisors who provide expertise about ETF portfolio construction and trading to other advisors seeking outsourced model portfolios.

A premium on liquidity

Institutional investors need liquidity sources that can provide market exposure to minimize cash drag. Consequently, the iShares report finds institutional clients increasingly implementing overlays that include ETFs in order to mirror the risk/return profile of some or all of their policy portfolio. In 2012, 31% of institutions implemented such an ETF strategy, up from 3% in 2010.

More demand for fixed income ETFs

Increased market volatility and decreased bond issuance may cause more institutions to use ETFs to access and manage their fixed income exposures more efficiently. In 2012, fixed income ETFs had record inflows of $70 billion. This year, money likely will keep flowing into developed market fixed income ETFs for passive core allocation, tactical strategies, transitions and risk management. Moreover, institutions attracted to the emerging world’s improving conditions may also invest in emerging market fixed income ETFs.

 “In the coming year, investors are likely to face continued market volatility while they search for yield in a low rate environment,” Daniel Gamba, head of iShares Americas Institutional Business at BlackRock, said in a statement. “Given these dynamics, we see the trend of institutional investors using ETFs, particularly as part of the core of their portfolios, continuing in 2013.”

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