FTSE Russell breaks down how pension plans evaluate index exposure and why bespoke benchmarks are replacing the catalogue approach
Each month at BPM, we offer a slate of articles and content pieces that go deep on a particular topic. This month, we're focusing on ETFs, how pensions are using them and the role it plays in institutional portfolios.
The exchange-traded fund (ETF) market has moved well past its origins as a vehicle for cheap beta. According to FTSE Russell, institutional investors and plan sponsors are now working together with index providers and ETF sponsors to build custom indices.
"So many of the sponsors and manufacturers of ETFs today are co-creating exposures with investment managers. Many work at the largest institutional clients, and that's probably the biggest trend we've seen," said Anthony Rochte, global head of sales at FTSE Russell.
Plan size shapes ETF custom index demand
Arne Noack, head of equity and multi-asset indices, Americas, at FTSE Russell, agrees that the appetite for customization among North American pension plans is well-established, though he frames it as a constant rather than a sudden spike. Where he draws a sharper distinction, though, is in how plan size determines the shape of that customization.
According to Noack, larger plans tend to maintain internal teams capable of implementing portfolios that track a bespoke index, while smaller plans lean on consultants and outside asset managers, adding the result is a triangulated relationship among index provider, asset manager, and plan sponsor that can obscure who is driving the investment thesis.
For Rochte, factor-based customization is fundamentally about giving institutional investors more control over their exposures, and he expects the range of available strategies - from bank loans to derivative overlays - to sharpen that control further.
He noted large pension plans are now approaching ETF sponsors directly to build bespoke indices and seed them with capital, a model that first gained traction when European plans backed ESG-focused ETFs with two of the industry's largest sponsors.
"On one hand you have this choice and the precision. On the other hand, you've got more ETF sponsors willing to customize, particularly with institutional clients and pension plans because they can help seed the exposure," he said.
Additionally, both Noack and Rochte highlight that factor-based and rules-based strategies are central to the customization conversation.
Rochte said the institutional community was familiar with factor investing long before factor ETFs brought the approach to retail audiences roughly 15 years ago.
"When you look at factor customized strategies, it's really delivering precision," he said. "With the choices available today, everything from bank loan to derivative overlay strategies, I think that precision is going to become even finer in the coming years."
Plan sponsors consider outcomes of ETF indices
Noack agrees, noting that the role of factor indices in rules-based investing “is very commonplace and continues to be” among large plans. But he adds a practical layer to how plan sponsors navigate the evaluation framework. The process starts with the investment decision: what exposure does the CIO need, and how does the plan's investment policy define a given market segment?
"A lot of pension plans have adopted the Russell 1000 as their definition for US large and mid caps, and therefore the Russell 1000 tends to be then the policy benchmark for that segment of the market," he said.
From there, the CIO determines the level of conviction - whether to track the benchmark outright or express finer points through factor tilts in value, quality, or growth. The more specific the idea, the less likely it ends up inside a standard ETF.
"The index that gets customized for a plan is then created and implemented specifically and solely for this one plan," he said.
Where custom indices fit in portfolios
Meanwhile, Noack explained custom indices built for pension plans are almost always implemented inside dedicated portfolios rather than launched as ETFs for broader consumption. The rare exception is when both the plan and its asset manager believe the idea has mass-market appeal.
That separation between custom indexing and ETF usage does not diminish the case for ETFs within institutional portfolios. However, Noack believes the efficiency gains around trade execution, pricing transparency, and running costs have made the wrapper far more attractive to pension plans, insurance companies, and other institutional allocators.
Additionally, fees across a wide range of equity exposures have fallen to low single-digit basis points, which equates to a steep drop from where the market stood when he entered the ETF industry two decades ago, he noted.
The market-making infrastructure behind those products has also matured, delivering tighter execution across both plain-vanilla and more specialized strategies. Noack pointed to an additional layer: certain high-volume ETFs, such as those tracking the Russell 2000, now support active securities lending markets that generate incremental income for holders.
Still, low single-digit basis points are now standard on a wide range of equity exposures, Rochte noted.
Institutional education still required for ETFs
"ETFs are just simply lower cost than many other vehicles out there," he said, while acknowledging that institutional investors also have access to collective vehicles that compete on price.
"It all goes back to education, whether it's education to the end investor, to the wealth advisor or to the head of a pension plan," he said.
Noack frames the shift less as an education gap and more as a recognition gap. He suggests the most meaningful shift he sees is not in flows but in how plan sponsors and their consultants perceive index providers.
“Perhaps that could be an expression of perception of what indexes are simply seen for,” he said. “We have to work our way around them, to really recognizing indices and index providers as partners for solutions for portfolios specifically.”
