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iShares reports emerging market demand buoys global bond ETFs to new heights


iShares reports that the third quarter of 2016 saw their European bond ETFs cross US$100 billion for the first time as deepening ETF liquidity and instant access to markets on demand attracted flows. 

The US-listed AGG became the first bond ETF in the world to surpass USD40 billion in assets and 2016 has now seen the fastest growth rate in global bond ETFs since 2012, with European and US markets tripling in size over the last six years.                 
Stephen Cohen, Head of Fixed Income Beta at BlackRock says that rising demand for emerging market bonds as a source of yield pick-up has led to record inflows into emerging market ETFs.
“Globally, Q3 witnessed the highest inflows into these ETFs of any quarter with USD5.8 billion, Q2 was the previous best with USD5.4 billion. Year-to-date, these ETFs have reached inflows of USD12.7 billion, well-above the previous full-year record of USD8.3 billion from 2012,” Cohen says.
“European investors have shown interest in both local currency (IEML) and dollar emerging market debt exposures (IEMB), compared with US counterparts where flows have been seen exclusively in dollar EMD, suggesting Europe-based investors have more comfort expressing views in emerging markets currencies. Year-to-date, IEML has more than doubled in size from USD1.8 billion to USD4.6 billion.
“US investors continued to use bond ETFs for income, with USD emerging markets, USD credit, and US multisector funds leading inflows.  AGG became the first bond ETF in the world to surpass USD40 billion in assets.
“Central bank actions continued to drive flows. Demand for European corporate bond ETFs following ECB action showed no sign of abating. We saw USD1.9 billion inflows into the largest five iShares Euro corporate bond products (IEAC, IBCX, IHYG, IE15 and IEXF) during the quarter, and USD6.8 billion year to date.
“Investors also increased their allocations to Sterling corporate bond ETFs (e.g. ISXF, IS15, SLXX) immediately after the BoE announcement of their Corporate Bond Purchase Scheme. Similarly the negative yields in Euros across much of EMEA has led clients seek an alternative to the significant cost of holding Euros in cash or money market funds. We’ve seen 400 per cent+ increase year to date in AUM in our EUR Ultrashort Bond ETF (ERNE).”
Cohen explains that size matters because deeper liquidity in larger funds means greater flexibility: during periods of volatility or market stress, a larger fund – with more diversified shareholder base and active secondary market – provides investors with more potential trading partners to get into or out of a position.
“Scale makes ETFs more relevant for some investors: some institutional investors may have capacity constraints on what percentage of a fund they can own or require funds to be over a certain size before they can invest. The larger the fund the greater the flexibility in the amount they can trade to achieve their desired exposures.
“Larger funds tend to create new use cases: for example, the larger the fund the more potential for the market to develop lending markets using the fund as well as options on the fund.”
 Finally, looking ahead to Q4 2016, iShares expects the trend in emerging market investments to continue. “We believe EM assets can withstand a gentle rate hiking path set out by the Fed, given the fundamental improvement emerging market economies have undergone in recent years.
“More investors want to know about SRI / ESG exposures to bond markets. As recent news events have raised awareness of corporate governance and sustainability as drivers of long term performance, we expect this to be a long term trend that will continue into 2017.
“Investors will continue to be challenged by persistently low global bond yields.  We expect flows into low cost products like ETFs to continue as investors seek to cut fees to preserve income.”

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