The exchange traded fund universe has enjoyed decades of growth, but the bond ETF segment has been largely overshadowed by its equity ETF counterpart. However, things could change as more investors adopt fixed-income-related ETFs.
While many have witnessed the rapid growth of the ETF industry, ETFs are still only a very small part of the U.S. equity and bond businesses, making up 1% of the $49 trillion bond market and 8% of the $26 trillion stock market, reports Bob Pisani for CNBC.
However, the industry is quickly changing. Martin Small, head of iShares America, projected that the ETF business could eventually grow to 50% of the U.S. stock market form the 8% today, and it is only a matter of when. On the fixed-income side, Small estimates the business could double or even triple in the next five years as bond ETFs grow to $1 trillion to $1.5 trillion in assets under management, or less than 5% of the total bond market.
ETFs’ success story has been attributed to their cheap and efficient ability to provide broad market exposure.
“People have come to understand the merits of index investing: you keep more of what you earn,” Small told CNBC.
Looking ahead, some of the biggest ETF providers, such as BlackRock, Vanguard and State Street, are eyeing institutional investors like sovereign wealth funds, university endowments and professional asset managers as potential big money investors to increase demand for bond ETFs.
“We’d like bond ETFs to be as ubiquitous as bonds and bond futures,” Small said.
Small pointed out that 10-year Treasury futures – one of the most widely used securities by professionals – trade about $146 billion per day. Bond ETFs, on the other hand, trade around $6 billion per day, or 4% of the volume of those Treasury futures. Small argued that this opens up a big opportunity for the ETF industry, especially as more professional investors put money into bond ETFs in the future in response to the shift toward electronic trading, a shift that occurred in the stock market side a decade ago.
“Bond investors still pay a lot of money for the market, many still pay a 1 percent fee,” Small said, explaining that electronic trading will make the market more efficient, less expensive and will open up even more opportunities for lower-cost ETF providers.
Related: A New ETF That Tries to Outperform the S&P 500 as Rates Rise
Regulatory changes could also support the bond ETF industry, with new regulations coming into effect in April 2018 that will require disclosure of bond markups.
“People who are charging a 1 percent commission are going to have to explain why that is a better deal than owning a bond ETF,” Small said.
For more information on the fixed-income market, visit our bond ETFs category.