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Half of Canadian institutions polled have replaced a derivatives product with an ETF for the sake of simplicity, the report says.NicoElNino/Getty Images/iStockphoto

Canadian institutional investors are broadening their use of exchange-traded funds as they seek to limit costs in their quest for liquidity and diversification, according to a new report.

Professional money managers are increasingly turning to certain kinds of ETFs that promise to boost returns in the persistent low-interest-rate environment, which has also inspired forays into alternative asset classes. Some of these newer products can also mitigate risk compared with other ETFs by targeting stocks with a lower volatility profile.

These are among the findings of an industry report, entitled ETFs: "Active" Tools for Institutional Portfolio Managers, that is to be released on Thursday. The study was produced by U.S.-based consultancy Greenwich Associates LLC and sponsored by BlackRock Inc., which owns the iShares line of ETFs. The survey is a snapshot of the sector based on responses from 53 Canadian institutional investors, including funds, asset managers and insurers.

"ETFs are as common as stocks, bonds and derivatives in these institutional portfolios now," Warren Collier, head of Canada iShares for BlackRock Canada, said in an interview. "You're seeing them become just another instrument used by institutions." He added that this growth is coming after years of educating investors on the ways ETFs can be employed to meet specific goals or solve certain problems.

In fact, Canadian institutions that use ETFs invest an average of 16 per cent of total assets in the funds, the study says. When it comes to allocations, 90 per cent were invested in equity-focused ETFs and nearly 60 per cent in bond ETFs. These funds, which trade like common stocks, can be easier to get in and out of than the underlying assets they track.

"The cost of getting access to fixed-income securities directly is going up and ETFs are providing a solution to that," said Mr. Collier, adding that concerns about liquidity are a key driver behind the uptake of bond ETFs. "We expect to see that category continue to grow quickly."

Half of Canadian institutions polled have replaced a derivatives product with an ETF for the sake of simplicity, the report says. On the other hand, nearly one-third of respondents said they are using more innovative funds, called "smart beta," for their blend of active and passive styles of investing. These funds use different kinds of investment weighting strategies, rather than sticking to a market-cap weighting. They can be a way to diversify portfolios, since they look at an investment's size, volatility and value.

Part of the reason that more investors are looking to these strategies could be that there are more smart-beta funds available today. One survey respondent, an equity-portfolio manager for a Canadian asset-management firm, told Greenwich that "there are more ETF products with interesting uses, which provides easier access to areas I might not have had otherwise."

Of these investors, more than half plan to increase their exposure next year. None said they would decrease their exposure.

Last year, none of the funds polled invested in dividend/equity-income ETFs, but in this year's report about 50 per cent of respondents said they had exposure to these funds, which are attractive to investors because they are a source of income.

"The uptick in demand for dividend/equity-income ETFs suggest that institutions' concerns about market volatility were matched by their need for returns in the low-rate environment that persisted in 2016," the report states.

But not all Canadian institutions view ETFs as the panacea for their investment struggles. There are three main reasons why investors shy away: "concerns about liquidity, expenses and investment guideline restrictions that limit or prohibit investment." But some of those concerns are abating, the report says.

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