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BlackRock’s Olson comments on inflation concerns and sustainability driving bond ETF flows in EMEA

Brett Olson, Head of iShares Fixed Income EMEA, has commented on the top themes influencing how clients are thinking about their ETF fixed income portfolios in the EMEA region, with inflation and rate volatility top of their minds. 

He observes that sustainability inflows contrast broader fixed income outflows and that high yield and emerging markets are in the spotlight amid the search for yield. 

The key question on the lips of many investors looking to shore up their fixed income exposures against the potential for inflation and rate volatility is are we in a rising rate environment, Olson says. 

“Looking beyond the transitory nature of the current inflation surge linked to the reopening dynamic, the BlackRock Investment Institute (BII) points to inflation building steadily over the medium-term as easy monetary policy allows the U.S. economy to run hot. 

“Bond ETF flow data show investors are moving their allocations to use inflation-linked bonds with YTD inflows of USD3.0 billion at 31 May 2021, vs. USD4.2 billion for the entire year of 2020, as well as short duration corporate and government bonds to minimise rate volatility. 

“The liquid, flexible nature of fixed income ETFs is enabling investors to remain nimble and stay adaptable to changing market conditions,” Olson writes. 

Sustainable flows across all major fixed income asset classes continued to be positive with total flows into fixed income ESG ETFs coming up to USD12.6 billion as at end of 31 May 2021, mainly driven by investment grade credit, which accounted for 73 per cent of this total. 

Sustainable fixed income ETF flows are by far exceeding industry inflows into traditional, non-ESG exposures year-to-date – which stood up to only about USD3.3 billion as of end 31 May 2021, Olson writes.  

“Investors increasingly want to understand the impact of sustainability on their fixed income sleeve. Despite growing investor caution on fixed income as an asset class in recent months, the trend of switching out of traditional or non-ESG funds and actively transitioning into sustainable exposures is accelerating.” 

Olson also comments that the search for yield continues, writing: “Today’s fixed income markets are mainly driven by central bank policies, which in turn have caused negatively yielding debt to grow at a record pace. The extraordinary level of central bank stimulus has pushed interest rates lower, and as a result, the search for yield has never been stronger. 

“High Yield continues to be in favour by investors in 2021, as it is also a lower duration asset class, relative to Investment Grade, in addition to its strong fundamentals. HY ETFs saw USD2 billion of inflows as at 31 May 2021, with a strong preference for USD HY exposures supported by lower EUR/USD hedging costs, along with the higher exposure to energy names. 

“HY has traditionally been viewed through a lens of requiring specialist knowledge and expertise in order to ‘pick and choose’ between the best names in the sector. However, as the ongoing hunt for yield continues, HY debt may benefit from inflationary pressures as investors may prefer the shorter duration exposures that HY offers versus investment grade debt. In this space, more and more clients are using ETFs to bring diversification and flexibility to their portfolio alongside alpha and index exposures.” 

Olson writes that looking at the portion of the fixed income market which yields over 2.5 per cent, more than half is made up of China bonds and investors are increasingly taking note. “The 5-year China government bond yield is at 3.0 per cent compared to the equivalent 5-year US Treasury which is yielding just 0.9 per cent, offering a 2.1 per cent yield pick-up. The inclusion of onshore bonds into global indices provides a structural tailwind and low correlation with other major markets is attracting investors looking to build resilience against market volatility.” 

Against this backdrop China on shore bond ETFs gathered more than USD4 billion inflows as at 31 May 2021, mainly used for strategic asset allocation purposes from a diverse set of investors across asset owners, asset managers and wealth as well as from multiple regions. 

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