Investors have increasingly turned to exchange traded funds as their go-to investment vehicle of choice for fixed-income exposure as liquidity in the underlying debt market dries up, especially after the new banking rules.
For instance, investment-grade corporate bond ETFs attracted $7.7 billion in net inflows over the first nine months of 2015, according to S&P Capital IQ.
“While we think demand for high-quality fixed-income securities is strong, in light of modest Treasury yields, inflows have also been aided by actions banks have taken to reduce inventories of bonds Available for Sale,” Todd Rosenbluth, Director of ETF Research at S&P Capital IQ, said in a research note.
After the 2008 financial downturn, the Securities and Exchange Commission has enacted new rules for the banking sector. Specifically, banks have increasingly placed their holdings of bonds into held-to-maturity portfolios, with banks’ HTM portfolios up to 20.7% of all securities at the end of Q2 2015, from 17.5% year-over-year.
The HTM portfolios are not subject to quarterly mark-to-market adjustments, so they do not impact a bank’s capital levels the same way bonds available for sale are, which is an important difference as Basel III capital rules go into effect – under Basel III rules, banks are required to count gains and losses in the price of these securities as part of their Tier I common equity.
Erik Oja, S&P Capital IQ banking equity analyst, also found that banks like JPMorgan (NYSE: JPM) have to return excess capital back to shareholders over the past five years. Additionally, Oja added that the Volcker rule, which prohibit banks from proprietary trading such as certain speculative investment activities, has significantly diminished fixed income trading activity at major banks.