Professional Demand for Bond ETFs Remains Robust

Despite all the talk of rising Treasury yields chasing investors from fixed income exchange traded funds, demand for such products remains robust, according to a recent study.

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, notes that bond ETFs are taking on increasingly important roles in institutional portfolios.

“For institutional investors, the legacy of crisis has included structural developments making it more challenging for institutions to execute trades and manage their fixed-income allocations. Stricter regulations on banks have forced many fixed-income dealers to rein in their traditional role as market makers. At the same time, a dramatic increase in bond issuance has not been matched by an equal rise in secondary market trading volume,” according to the study.

Amid heightened liquidity concerns, ETF issuers are taking steps to handle mass redemptions in bond ETF should a negative liquidity event transpire. The Vanguard Group, Guggenheim Investments and First Trust are among U.S. ETF companies that have expanded their bank guarantees to access more cash, Reuters reports.

For instance, First Trust raised its credit line to $80 million at the end of last year, the most recent reporting period, from $20 million in early 2013. The line is shared by two of its ETFs and two mutual funds with $645 million in assets under management. Vanguard engaged its first committed bank line of credit last year and now has access to $2.89 billion from multiple banks. State Street and Invesco PowerShares have opened credit lines for their respective senior loan ETFs. [ETF Providers Allay Bond Liquidity Concerns]

More than 50% of the participants surveyed by Greenwich Associates say liquidity issues have a had a direct impact on their investment process. However, use of fixed income ETFs is on the rise.

“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.

Increased use of bond ETFs by institutional investors jibes with the findings in the 2014 survey conducted by BlackRock and Greenwich Associates. At the time of publication, the 2014 survey predicted “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.” [Institutions Boost use of Fixed Income ETFs]

Institutional investors are increasingly turning to fixed income ETFs to express fundamental views while coping with low interest rates and the potential for increased bond market volatility.

“As institutions shorten duration, diversify portfolios and seek out sources of attractive return by shifting assets to specialized and niche investments, they have found ETFs to be highly flexible tools to address both long-term strategic and short-term tactical investment objectives,” notes this year’s study.

Year-to-date, the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEArca: LQD) is the only bond ETF among the top 10 asset-gathering ETFs, but bond proxy funds, such as the Consumer Staples Select Sector SPDR (NYSEArca: XLP) and the iShares Dow Jones US Real Estate Index Fund (NYSEArca: IYR), are among the 10 worst ETFs for outflows suggesting that some investors remained concerned about higher interest rates. [Rough Times for Bond Proxy ETFs]