By Todd Rosenbluth, CFRA
Advisors are increasingly gaining comfort in using bond ETFs to build portfolios and continue to plan to move assets away from mutual funds and individual bonds. Yet, relative to equity ETFs, more advisors favor the diversification and ease of exposure benefits of these products, while viewing performance as less meaningful.
These are some of the key takeaways from a recent Cerulli Associates survey of 378 advisors that manage at least $50 million in assets and take discretion over half of the assets. Bond ETFs comprised just 18% of exchange traded market at the end of May 2017 according to etf.com data, but pulled in 28% of the inflows this year.
CFRA thinks that growing comfort by advisors will help to spur additional inflows in the coming years. Half of the advisors surveyed planned to increase usage of bond ETFs in the next three years, while only 12% expect to decrease usage. In contrast only 23% and 18% of advisors aim to add individual bonds and bond mutual funds, respectively, while 29% and 39% anticipate decreasing usage in these income-generating products.
iShares fixed income strategist at Blackock Karen Schenone thinks many advisors are discovering that bonds ETFs offer the same benefits as equity ETFs – a low cost and tax efficient way to invest. BlackRock sponsored the report with Cerulli Associates.
However, investors need to understand that various ETF providers offer low-cost products in these investment styles and the portfolios are not identical.
For example, iShares Core 1-5 Year USD Bond ETF (ISTB) and Vanguard Short-Term Bond ETF (BSV) are available for net expense ratios of 0.08% and 0.07%, respectively. In contrast, the average short-investment grade debt mutual fund had a net expense ratio of 0.76%. One example among the mutual funds with $500 million in assets and an above-average expense ratio is Lord Abbett Short Duration Income Fund (LDLAX).
ISTB’s three-year track record as of May 31 of 1.41% was ahead of BSV’s 1.13%. The iShares product sports a higher yield, due to greater exposure to investment-grade corporate bonds and less exposure to government bonds.
Meanwhile, within the high yield investment style, iShares iBoxx $ High Yield Corporate Bond (HYG), PowerShares Fundamental High Yield Corporate Bond Portfolio (PHB) and SPDR Barclays High Yield Corporate Bond (JNK) have net expense ratios of 0.50%, 0.50% and 0.40%, respectively. All of these ETFs products are cheaper than the 1.1% charged for the average high yield bond mutual fund. Yet the exposures they provide are different.
PHB has more in BBB-rated securities (13% of assets) than its peers, while JNK takes on more credit risk and has 16% in bonds rated CCC or higher; HYG has more diversification across the credit rating buckets that PHB and JNK. These ETFs have a combined $30 billion in assets under management. In late 2016, Deustsche X-Trackers US High Yield Corporate Bond (HYLB) launched and has a 0.25% net expense ratio. The $190 million ETF has credit exposure most similar to HYG.
One example among the high yield mutual funds with $500 million in assets and an above-average expense ratio is Ivy High Income Fund (WRHIX).
The most significant reason advisors prefer bond mutual funds over bond ETFs, according to Cerulli, was their preference for active management (62%), ahead of the advisor (33%) or the client (19%) being more familiar with mutual funds.
So while greater education about the benefits of ETFs could convince this subset of advisors to further implement bond ETFs, we think new actively managed ETFs could drive adoption. First Trust TCW Opportunistic Fixed Income (FIXD) and Hartford Corporate Bond ETF (HCOR), the latter sub-advised by Wellington Management, launched in 2017, joining a smaller but growing group of bond ETFs managed by prominent managers from DoubleLine, Fidelity, Guggenheim and PIMCO.
Schenone of iShares thinks we’re only in the second inning of advisors using bond ETFs across their practice.
CFRA agrees the environment is ripe for bond ETFs to gain additional assets in the next few years as advisors gain comfort with these passive and active products. We have rankings on approximately 230 bond ETFs, based on a combination of holdings-level analysis, including credit ratings and duration, and fund-level attributes, such as expense ratio and bid/ask spread. Our reports can be found on this platform.
Todd Rosenbluth is Director of ETF & Mutual Fund Research at CFRA.