Providers of exchange-traded funds say they are excellent investment tools with a wide variety of uses for pension funds. But while many continental European pension funds do take advantage of the flexibility ETFs can offer, their UK counterparts appear to steer clear.
In Germany, open pension fund HVB Pensionsfonds says it uses ETFs very extensively both in its equity and bonds allocation. A spokeswoman points out that though the scheme was the first open pension fund on the German market, it is still relatively young in comparison to other providers.
“Therefore the solution needed here is an investment that most importantly matches our investment guidelines, closely follows the benchmark, has low-cost structure and is flexible in its execution and so can be done quickly and easily,” she says. All of that is offered by ETFs, and these are the reasons why the fund has chosen them as one of the instruments to implement its investment strategy.
At the other end of the fund spectrum, the Netherlands industry-wide pension fund for the civil service, ABP uses ETFs in its allocation process. But only if they provide enough liquidity, and are not too expensive. But in most cases, the fund is quick to point out, ETFs are too expensive.
The Novartis pension fund in Switzerland says it uses ETFs for tactical reasons within its beta portfolio. The pension fund portfolio contains three elements – a safety-portfolio which contains high quality fixed income, mortgage and real estate, an alpha portfolio which contains long-term investments in equities and a beta portfolio which uses ETFs.
But in the UK, some pension funds say ETFs are simply unsuitable for them because they do not need instruments which allow them to move so quickly. The British Steel Pension Fund has a relatively stable asset allocation, Stuart Colley, the fund’s investment manager has said. ETFs give you the ability to get in and out quickly, he said, a facility which is not particularly useful for his fund.
And the Diageo pension fund in the the UK also says it sees no use for ETFs. The strategy is set up with a long-term view, Paul Charles, pensions strategy and policy manager has said, and it is viewed as something which doesn’t need to react in the short-term.
Marc Russell-Jones of custodian Bank of New York questions whether pension funds in the UK are using ETFs directly. “I still haven’t seen evidence of it,” he says. However, some of the more sophisticated larger funds could use them directly, but he says there are cheaper alternatives to give index exposure.
The main users of ETFs are the fund manager and hedge fund communities, he says. “Just about every hedge fund we talk to uses sector ETFs in some way or another.” Mutual fund managers use ETFs to reduce cash drag, he says.
Ralph Frank, senior investment consultant at Mercer Investment Consulting, agrees that it is still rare for pension funds in the UK to use ETFs. “For institutional investors in the UK it’s often much more efficient to use other forms of pooled fund, particularly since in the UK you are liable to pay stamp duty on UK listed ETFs,” he says. When this is added to the brokerage costs as well, it can push the costs of ETFs above alternatives.
Also, because of the UK/US double tax treaty, pension funds will not be able to reclaim withholding tax on dividends incurred within the ETFs, which means foregone returns in the region of 0.25% per annum for an ETF investing wholly in US equities. “There are a number of factors that have mitigated against ETFs in the institutional market,” he says.

Topics