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Beverly Chandler, GFM

Fixed income ETFs enjoy steady growth


Bond ETFs have enjoyed a recent period of steady growth. Being able to invest in a bond portfolio within an equity structure makes them pretty appealing to institutional investors and retail investors alike.

A recent study from Greenwich Associates found that diminished liquidity in global bond markets is fuelling demand for fixed income ETFs among institutional investors in Europe and the United States. A large majority of the institutions in the most recent Greenwich Associates Fixed-Income ETF Study say they face increasing challenges in trading, liquidity and security sourcing. 

The situation appears particularly tough in Europe, where 78 per cent of institutions say trading, liquidity and security sourcing in fixed income markets has become more challenging. Sixty per cent of study participants report that it’s become more difficult to execute large bond trades over the past three years. Over two-thirds of respondents overall reported these changes are impacting their investment management processes.

As a result, Greenwich Associates says, 60 per cent of institutions have increased their use of bond ETFs in the past three years, with allocations now averaging roughly 18 per cent of total fixed-income assets.

There are over 900 bond ETFs globally and figures from the Investment Company Institute’s recent review of ETFs revealed that issuance of US-registered bond and hybrid ETFs went from USD85 billion in 2016, to USD123 billion in 2017. Data to beginning of September 2018 data showed US-registered bond and hybrid ETF issuance at USD97 billion.

And it is a similar picture in Europe, with UCITS ETFs in fixed income and allocation enjoying issuance figures of EUR23 billion in 2017. The post financial crash regulatory developments have made it increasingly difficult for banks to hold inventory and support liquidity on their balance sheets, making direct investment in the bond markets increasingly inaccessible for institutional investors.

Whereas, before the crash, fixed income and bond ETFs were often used by wealth managers or smaller institutions who couldn’t directly access the bond markets, increasingly they are being used by institutional investors as a low cost route to the bond markets through an equity transaction.

This year has seen the launch of an ETF provider in Europe, devoted to fixed income ETFs. MJ Lytle’s Tabula Investment Management, also profiled separately in this report, launched with a survey of institutional investors and wealth managers. The survey revealed that there are around 400 fixed income ETFs listed in Europe at the moment, with 64 per cent of the surveyed audience expecting that figure to grow. 

In terms of ETF asset growth, Tabula’s research found that just over half (53 per cent) of those interviewed expected the amount invested globally in fixed income ETFs to reach USD1.6 trillion by the end of 2020 – a rise of 167 per cent on 2016.

Drivers of growth in fixed income ETFs include the low cost of trading, ease of access to trading plus the in-built transparency, liquidity and intra-day access of an ETF in what has traditionally been a relatively illiquid asset class.

According to iShares, the US trading of bond ETFs averages over USD200 billion a month, roughly USD7 billion a day. Their studies, focussed on two representative bond ETFs, one USD investment grade corporate and the other USD high yield corporate show that there has been a higher frequency of large trade sizes in bond ETFs. 

In 2010 large trades – single trades greater than USD10 million – accounted for 6 per cent of a representative US investment grade corporate bond ETF’s and 3 per cent of a representative US high yield corporate bond ETF’s total trading volume. iShares reports that today, trades of those size have climbed to between 15 and 20 per cent of trading activity for both ETFs. 

The figures show that fixed income ETF inflows are consistently growing across the US and Europe driven by another key driver: the ageing populations of each continent. Ageing populations who need regular income in retirement require lower risk and lower volatility investments and fixed income ETFs tick all these boxes. 

Fixed income ETFs can offer exposure to a broad range of sectors in the markets, beyond government bonds to investment grade corporate, high yield corporate and emerging markets.

Fran Rodilosso is head of fixed income ETF portfolio management at VanEck and his team is responsible for managing approximately USD13 billion through 19 ETFs in the US and Europe, across a wide variety of investment options.

In a recent interview with etf express, Rodilosso commented that the two questions he gets asked the most is how to protect from rising rates, including what is going to happen with rates as the US, Europe and Japan exit the strategies they have pursued and when is the credit cycle going to turn and will there be a high level of defaults.

Investors are nervous as interest rates rise that bond values may fall, but Rodilosso has found that the rate picture in the US has been one of a steady period of normalisation which has caused less disturbance in the credit markets than investors may have feared.

Rodilosso says of the US: “Spreads have held in, supply and demand has remained balanced.”

As central banks start to clear their balance sheets, Rodilosso advises looking at what they actually hold, pointing to Japan, which famously holds a large number of ETFs.

More research from new ETF providers Tabula Investment Management reveals that over the next 24 months, when considering a range of fixed income and debt investment vehicles, those linked to credit and inflation will see the biggest increase in demand from investors. Investors highlighted investment grade credit where 42 per cent of those interviewed expect demand to increase compared to 10 per cent who think it will fall. 

Some 48 per cent of institutional investors and wealth managers interviewed expect demand for inflation strategies to increase between now and 2020, and just 2 per cent anticipate a fall, according to the research. 

The findings from Tabula reveal other fixed income/debt strategies that investors expect to see a net increase in demand over the next two years include high yield credit, emerging market debt and asset backed securities. Demand for government bonds will remain relatively flat.

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