Brett Olson (pictured) Head of Fixed Income iShares EMEA at BlackRock, believes that the period of volatility in Spring 2020 was a turning point for fixed income ETFs, and that now is the time for investors to rethink their approach to fixed income allocation.
“The crisis earlier this year showed that the ETF structure is resilient to market shocks, while the dramatic rise in secondary market trading volume proved that in times of stress, more money turns to ETFs to trade, either to add risk or de-risk,” says Olson.
According to Bloomberg, as of 20 March 2020, the average weekly iShares fixed income ETF trading volume was just under USD18 billion per week, whereas the 2019 average weekly trading was around USD8 billion. The iShares’ flagship Core Euro Corp Bond UCITS ETF (IEAC) fund traded EUR1.2 billion on 6 March. This was over 6.5 times the 12-month average daily volume.
“We had not seen the secondary market tested in this way, particularly in the UCITS space and with every asset class under pressure at the same time and very quickly,” says Olson.
The volatility in early 2020 was no doubt a turning point in the evolution of fixed income ETFs. However, Olson believes that this has been a long time coming. He attributes the growth to four main drivers – the evolution of portfolio construction, the modernisation of the bond market, continuous ETF innovation and the proliferation (or growth) of adoption of ETFs themselves.
Global fixed income ETF assets under management as of 26 June 2020 were USD1.4 trillion and of that, BlackRock manages around 48 per cent, according to Bloomberg. In EMEA BlackRock has a 60 per cent market share.
“Investors have learnt that they can use index products at the core of their holdings. By combining these lower cost ETF exposures with high conviction active strategies, investors can create more diversification and flexibility to their fixed income allocation. This is certainly more of a “barbell” approach than we have seen historically,” says Olson.
He explains that BlackRock’s clients – asset owners, asset managers and wealth managers – are becoming ever more innovative in their use of fixed income ETFs.
Essentially there are six primary use cases for fixed income ETFs, continues Olson. For tactical asset allocation (TAA) or strategic asset allocation (SAA), as a liquidity sleeve, a derivative complement, for cash continuum or as a transition tool.
No client will use all six. For example, a wealth client will probably not use fixed income ETFs as a liquidity sleeve, however, an asset manager is likely to use them for liquidity as well as for TAA.
Some investors might use fixed income ETFs as a liquidity sleeve to manage the cash drag in their portfolios. “This is particularly useful for an active portfolio manager in order to ensure they are fully invested. If I put cash in a fixed income ETF, I can trade intraday and I can have a beta return on my portfolio,” says Olson.
Alternatively, some active bond managers will use ETFs to manage inflows and outflows in their own funds. For inflows, they might buy an ETF in a secondary market and only sell it when they find the bonds that they want to hold.
Banks or hedge funds might use fixed income ETFs as a derivative complement. “We see investors who may want to hedge their portfolios by borrowing ETF units on secondary markets – just like stock lending.
“On the corporate side, we are finding that in a negative rate environment, investors might look at fixed income ETFs for cash continuum via an ultra-short duration ETF – a one to three year government bond ETF – or an ultra-short investment grade product that has less than a half year of duration, to minimise the negative return that a cash deposit would create.”
Olson is also seeing multi-asset funds or asset owners using fixed income ETFs as a transition tool. If a manager is looking to transition from one active strategy to another, perhaps for performance reasons, they may not want to be out of the market.
Inevitably, currency hedging plays an increasingly important role in BlackRock’s fixed income ETFs, which is why a few years ago, it evolved its fixed income ETF platform to offer share classes of its funds.
“We found that it was easier to launch a new FX share class than a new ETF. The investors benefit from the overall size of the whole ETF and not just their share class, while we maintain operational efficiency.”
But perhaps one of the main illustrations that fixed income ETFs have come of age is from the fact that investors found more accurate price discovery in fixed income ETFs than in the traditional bond market during the crisis.
Unlike the equity markets where shares trade continuously, many bonds do not trade regularly, and companies can have many different bonds outstanding.
“This year, investors trading in fixed income ETFs found a clearer picture of where risk was trading. Some multi-asset investors were using the secondary market as much as they could to benefit from the tighter bid-ask spread. And we had also been hearing from investors that not only was it difficult to sell bonds, it was difficult to buy them too,” says Olson.
Now, underpinning all this is the growing demand for climate focus index products. Olson believes that sustainable index offering will play a key role in bringing sustainable investing into the heart of portfolios. A survey conducted by Greenwich Associates in March 2020 found that almost 60 per cent of institutional funds and insurance companies expect that 50 per cent of their assets are managed with an ESG criteria within 5 years.
It is also about better data being available which is leading to increased ESG coverage of indexable fixed income markets as well as because of the great wealth transfer to millennials which Olson foresees will gain traction in the coming years.
“BlackRock has sustainable fixed income solutions in many parts of the market, across EUR Govies, EUR & USD IG & HY as well as hard currency EM,” says Olson. The most recent launch is the iShares EUR Govt Bond Climate UCITS ETF (SECD).
“What is interesting is that throughout the volatile period, the flows in the sustainable range remained resilient, reflecting clients’ views of the products as a strategic holding. I would also argue that because of the volatility that we saw in the market, as people re-risked, more money went into ESG than we had anticipated.
“If this year has shown us anything,” adds Olson, “it is that fixed income ETFs proved their resiliency, are transforming the bond market and investors are placing indexing at the core of their fixed income allocation.”