ETFs Become a Primary Liquidity Tool for Institutions

Exchange-traded funds are steadily becoming part of the institutional investing toolkit. Once used almost exclusively for cash equitisation and transition management, ETFs are now gaining traction as long-term holdings for asset owners seeking liquidity, transparency, diversification and cost efficiency. With more than 9,500 ETFs globally and assets exceeding US $17.5 trillion, most of which remain in the U.S.-domiciled products, ETFs have firmly established themselves as a core component of institutional portfolios.

2025 has become a defining year for institutional adoption. U.S. ETF inflows alone have reached $1 trillion year-to-date, with two months to go.

ETFs Secure a Strategic Role in Institutional Portfolios

Over the past decade, institutional investors, pension funds, endowments, foundations, sovereign portfolios began using ETFs primarily for cash management. But as liquidity needs increased and market conditions became more volatile, many asset owners shifted towards ETFs as an elegant tool for transition management, with their intraday liquidity and transparency proving invaluable in periods of market stress.

Now, institutions are moving further…

ETFs are being used as strategic portfolio components instead of only being stopgaps. The industry’s scale means that institutions can now deploy hundreds of millions of dollars without distorting markets, opening the door for core exposure and risk-balancing roles that traditionally belonged to index funds or separate accounts.

ETFs Emerge as Durable Long-Term Allocation Vehicles

Preliminary results from Cerulli Associates’ 2025 asset-owner survey show that 27% of institutional investors now use ETFs as core holdings. Uptake is particularly strong among foundations and public defined-benefit plans.

“ETFs offer a low-cost way to gain broad market exposure while enhancing liquidity,” explains Jack Tamposi, associate director at Cerulli. For many asset owners expanding allocations to illiquid private markets, ETFs are becoming an important tool for public-market liquidity management.

The rise is also supported by structural pressures:

• Slower private-equity exits,
• New taxes on endowments,
• Reduced federal funding for certain institutions,
  all of which have pushed allocators to maintain more flexible public-market liquidity buffers.

Rapid growth and pressure on mutual funds

The momentum is unmistakable. Preliminary Cerulli research suggests that asset owners are more likely to increase ETF allocations and decrease mutual fund allocations over the coming years.

According to David Mann, head of ETF product and capital markets at Franklin Templeton, ETFs today cover an almost complete spectrum of strategies: passive, factor-based, thematic, active, single-stock, and even derivatives-based overlays.

“From an institutional perspective, there’s just more options across anything you want to do,” Mann says. Many ETFs have also crossed the $1 billion AUM mark, an important threshold for institutions that require scale before allocating.

The regulatory environment has also shifted.

• The SEC’s 2019 ETF rule opened the gates to a wave of new active strategies.
• The 2024/25 ETF share-class approvals such as Dimensional Fund Advisors’ greenlight to introduce ETF share classes for 13 mutual funds create a structure where asset owners can work with the same manager across SMAs, mutual funds and ETFs.

This continuity reduces operational friction and supports a more seamless transition into the ETF vehicle.

Smaller institutions are joining too

While large pension systems often rely on separately managed accounts with negotiated fees and transparency, smaller institutions are increasingly finding ETFs more efficient.

According to Erika Olson, director of public markets manager research at Meketa Investment Group, the early adopters among smaller and mid-sized institutions are using ETFs for niche exposures like sector tilts, credit pockets, or tactical positioning, where building an SMA would be impractical.

Will Forde, head of marketable equities at NEPC, notes that ETFs are especially compelling for:

• Factor exposures,
• Country or regional completion,
• Tactical hedging,
• Tax-loss harvesting (for taxable clients).

Operational simplicity is a major advantage because ETFs require no minimum size, have transparent pricing, and often deliver index exposure more cheaply than traditional index funds for smaller allocators.

Tactical tools with strategic implications

ETF usage among institutions is increasingly creative:

• Government pension plans have used bank-loan ETFs as temporary allocations while performing due diligence on private-credit managers.
• Some institutions are turning to digital-asset ETFs including bitcoin strategies for structurally small but operationally straightforward exposures.
• Others use ETFs to correct structural biases (such as underweighting a specific country or sector) or to quickly express tactical macro views.

“People get really creative with how to use things that even five or 10 years ago seemed pretty basic,” Forde says. “They’re using them in different ways.”

What’s driving institutional adoption?

1. Scale and liquidity
ETFs have reached a size where large ticket trades tens or hundreds of millions can be executed with manageable impact costs.

2. Transparency and governance
Institutions value the daily disclosure of holdings and the rules-based construction of index ETFs.

3. Cost efficiency

Relative to mutual funds or bespoke structures, ETFs often deliver cheaper access to the same exposures.

4. Structural innovation
ETF share-class structures, active ETFs, single-bond or single-stock ETFs, and options-overlay ETFs are expanding the menu.

5. Portfolio construction needs
As more capital moves into private markets, the public-market liquidity sleeve becomes increasingly important and ETFs fit neatly into that requirement.

ETFs moving from tools to building blocks

Institutional ownership of ETFs remains modest compared with the broader market, but the trajectory is unmistakably upward as regulatory alignment, expanding product diversity, and deeper track records strengthen the case for adoption.

The next phase is likely to centre on the maturation of active ETFs with established five-year histories, alongside the continued rise of ETF share-class conversions, which give asset owners more choice within familiar manager relationships. At the portfolio level, ETFs are becoming increasingly important as liquidity sleeves for institutions with growing private-market allocations, while smaller allocators continue to turn to ETFs for operational efficiency and cost-effective index exposure.

Fixed-income ETFs, particularly in high-grade credit and systematic bond strategies are also expected to attract greater institutional interest as product design evolves. As David Mann observes, “The knock-on effect of investors seeing more and more options within ETFs means now they want more and more options within ETFs.”

After a decade of proving their value as tactical tools, ETFs are steadily transitioning into strategic building blocks within institutional portfolios worldwide.