US research firm Greenwich Associates interviewed 128 US-based institutional investors between January and March 2015 about their use and perceptions of fixed-income ETFs.
The challenges posed by the global financial crisis continue to have an impact on the global fixed-income markets and (ETFs) are taking on an increasingly vital role in institutional portfolios. Greenwich writes: “For institutional investors, the legacy of crisis has included structural developments making it more challenging for institutions to execute trades and manage their fixed-income allocations.”
The firm found that stricter regulations on banks have forced many fixed-income dealers to rein in their traditional role as market makers. “At the same time, a dramatic increase in bond issuance has not been matched by an equal rise in secondary market trading volume. These structural developments are making it harder for institutions to execute trades and manage their fixed-income allocations.”
More than half the institutions who took part in Greenwich Associates 2015 U.S. Fixed-Income ETF Study that has experienced liquidity problems says these issues have had a direct impact on their investment processes.
“While institutions of all types have struggled with reduced liquidity in bond markets, ETFs have not suffered the same fate. Since 2008 bond ETF liquidity has grown more than four and a half times or at an annual growth rate of 33 per cent. Among a subset of the largest ETFs, growth in liquidity has significantly outstripped asset growth, implying that there is a sizable population of investors actively trading and driving the velocity of these funds.”
Overall, 59 per cent of fixed-income ETF investors in the study reported that they have increased their usage since 2011, with growing numbers of institutional investors turning to ETFs as a liquidity enhancement tool.
The report found that investors are increasing their ETF use by employing bond ETFs alongside individual bond holdings, or in place of futures and other derivatives. Institutions are also using ETFs to create overlays and liquidity sleeves designed to enhance overall portfolio liquidity.
Increasingly, institutions also are turning to ETFs to more readily achieve fundamental investment goals. “For the past several years, investors have been adjusting portfolios in response to historically low yields, the potential for a prolonged rising rate cycle and to better weather spikes in volatility.”
As institutions shorten duration, diversify portfolios and seek out sources of attractive return by shifting assets to specialized and niche investments, they have found ETFs to be highly flexible tools to address both long term strategic and short term tactical investment objectives.
Greenwich Associates data suggests that the growth of ETF usage by institutions is expected to be robust in the years ahead. “One-quarter of the institutions in the study – and 40 per cent of the investment managers – plan to increase their use of bond ETFs in the coming 12 months. Further, many institutions now report they have traded ETFs in large sizes of over USD50 million. Among these frequent fixed-income ETF traders, over 90 per cent say they were satisfied with their trading experience, and nearly all said they would trade ETFs again.”
Greenwich Associates found that the need for new approaches and growing familiarity of the products appears to have sped up the adoption of bond ETFs. “This momentum is likely to continue as institutions revisit internal investment guidelines and limits that had previously capped investors’ use of ETFs. Given these dynamics, Greenwich Associates expects fixed-income ETF usage will continue to build as institutional investors meet the realities of a challenging fixed-income marketplace with new and
broader allocations to this highly adaptable vehicle.”