A changing interest rate environment and post-financial crisis regulatory shifts are among the catalysts prompting institutional investors to increase their use of fixed income exchange traded funds.
The first U.S. fixed income ETF study by independent research firm Greenwich Associates and sponsored by BlackRock’s (NYSE: BLK) iShares unit, the world’s largest ETF issuer, shows 85% of current bond ETF users have employed such funds for at least two years while about two-thirds have boosted their usage of fixed income ETFs since 2011.
Bond ETFs have bucked the trend of departures from equity-based funds. U.S. bond ETFs have raked in $16 billion this month as of Feb. 21, the Wall Street Journal reported, citing TrimTabs Investment Research. That puts on bond ETFs for the biggest monthly gain since the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEArca: LQD) debuted in 2002 and is nearly double the previous record monthly inflow of $8.4 billion in May 2012, the Journal reported. [Bond ETFs: The New Black]
Greenwich Associates surveyed “110 U.S.-based institutional investors about their use and perceptions of fixed-income exchange-traded funds. The respondent base included 42 investment managers (firms managing assets to specific investment strategies/guidelines), 29 registered investment advisers, 21 institutional funds (pensions, endowments and foundations), and 18 insurance companies. The sample population comprised 59 current active users of fixed-income ETFs and 51 non-users in order to determine current and future use of fixed-income ETFs by active users, as well as the current reasons non-users don’t actively use fixed-income ETFs and their expected interest,” according to the consulting firm.
Liquidity and ease of use are the primary reasons institutional investors have increasingly embraced bond ETFs, according to iShares. Soaring assets across bond ETFs has helped elevate liquidity. Bond ETFs had a combined $246 billion in assets at the end of last year, according to iShares.
Still, some market participants have persistently raised concerns about potential liquidity issues in some areas of the bond market, particularly high yield and leveraged loans. Goldman Sachs recently implied that after being on the receiving end of inflows for 88 straight weeks, bank loan ETFs and mutual funds could be vulnerable to a reversal of fortune. [Goldman Cautious on Leveraged Loans]
Most of the institutions surveyed (65%) have made changes to their fixed income portfolios, according to the Greenwich survey. Those portfolio alternations are expected to continue increase and potentially increase over the next 12 months, according to the study.
Short-duration bond ETFs with less sensitivity to rising interest rates have been a favored destination for fixed income investors this year. Three of the top 10 ETFs in terms of year-to-date inflows, including the top two, are funds holding bonds with maturities of seven years of less. [Sifting Through Short-Duration ETFs]
“Institutions are re-examining their fixed income portfolios in light of an evolving market that is characterized by increased volatility, decreased liquidity and more challenging access. These trends are leading investors increasingly to fixed income ETFs as a way to source exposures, harness liquidity and efficiently implement desired investment strategies, said Matt Tucker, head of iShares fixed income investment strategy.
Among the various corners of the bond ETF market, U.S. Treasury funds are expected to see decreased usage over the next year with 30% of respondents to the Greenwich study saying they expect to reduce exposure to U.S. government bonds. Low duration or rate hedged funds are expected to see the biggest uptick in usage with 34% of respondents saying they will add exposure to those funds.
Twenty-four percent of respondents expect to increase exposure to high-yield and investment-grade corporates while 27% said they will boost allocations to emerging markets debt funds. [Big Inflows to Credit ETFs]
“The Greenwich report’s findings represent many of the conversations we have with institutions. They are making numerous portfolio changes and struggling with a more challenging bond market, which makes them open to using new investment tools,” said Daniel Gamba, head of iShares Americas Institutional Business.
