Benefits of the Bond ETF Bonanza

Amid liquidity concerns and interest rate challenges, fixed income exchange traded funds remain popular destinations for professional investors.

That much is apparent when reviewing the study, Bond Market Challenges Continue to Drive Demand for Fixed-Income ETFs, conducted by BlackRock’s (NYSE: BLK) iShares unit, the world’s largest ETF sponsor, and Greenwich Associates.

“Overall, 59% of fixed-income ETF investors in the study reported that they have increased their usage since 2011, with growing numbers of institutional investors turning to ETFs as a liquidity enhancement tool. Investors are increasing their ETF use by employing bond ETFs alongside individual bond holdings, or in place of futures and other derivatives,” according to the study. [Big Demand for Bond ETFs]

As that study notes, fixed income ETF volume has surged since the financial crisis. Data from S&P Capital IQ support that view.

“In the six calendar years since the onset of the financial crisis in 2008, fixed income ETF trading volumes grew more than 4.5 times or at annual rate of 33%. Over the same period, U.S. fixed income ETF industry assets grew to $297 billion, from $57 billion. As of April 2015, the industry had $336 billion in assets,” said the research firm in a note out Monday.

While it is institutional investors driving the asset and volume growth in bond ETFs, all investors are benefiting from that growth as improved liquidity pushes trading costs lower.

“We believe institutional demand for bond ETFs is positive for all investors as the enhanced liquidity keeps costs down. According to S&P Capital IQ, 20% of all fixed income ETFs trade with a bid/ask spread of $0.01 or $0.02,” said S&P Capital IQ.

Not surprisingly, robust bond ETF liquidity has fostered narrow spreads in U.S.-focused funds such as the iShares Core U.S. Aggregate Bond ETF (NYSEArca: AGG) and the Vanguard Short-Term Corporate Bond ETF (NasdaqGM: VCSH), but the same is true of some ETFs that track less liquid corners of the bond market, including the PowerShares Emerging Markets Sovereign Debt Portfolio (NYSEArca: PCY), according to S&P Capital IQ.

PCY, the second-largest U.S.-listed emerging markets bond ETF, tracks the DB Emerging Market USD Liquid Balanced Index. That is a proprietary index whereas most emerging markets bond ETFs are weighted by how much supply an issuer sends to market. [Advantages of EM Bond ETFs]

“Based on the study, growth of ETF usage is expected to be robust. One-quarter of the institutions in the study—and 40% of the investment managers—plan to increase their use of bond ETFs in the coming 12 months, while none of the respondents said both more common among institutional investors and more important within institutional portfolios,” according to the Greenwich Associates study. [Institutions Increase use of ETFs]