Some investors have been concerned about liquidity risks in the notoriously illiquid fixed-income markets that bond ETFs seek to reflect, but as volatility spiked in the first quarter, the ETF investment vehicle operated smoothly, albeit at a more active pace than usual.
“Investors navigated uncertain markets using bond ETFs to implement active portfolio decisions – positioning for rising rates and spread volatility using short duration, floating rate and hedged products,” Heather Brownlie, Head of iShares US Fixed income, said in a note.
Bond ETF asset flows revealed that investors utilized the investment vehicle to better manage risk in volatile market conditions. While many use ETFs for long term and core portfolio exposures, some investors incorporated ETFs to manage risk as geopolitical uncertainty affected market volatility and potential impact to global economies. For instance, the volume of ETF trading in the first quarter showed significant activity in U.S. Treasury, investment grade, emerging market and high yield bond ETFs.
Moreover, the heightened volatility also revealed how debt-related ETFs, especially high-yield ETFs, can provide a pool of liquidity to speculative-grade debt as an alternative to a notoriously illiquid over-the-counter bond market.
Related: ETF Trends Fixed Income Channel
Over the first quarter, U.S. bond ETFs gathered $15.6 billion in net inflows, with government bond ETFs leading by sector after attracting $7 billion, followed by broad funds $4.8 billion, international $2.3 billion and active short funds $2 billion.
Looking ahead, BlackRock sees opportunity in international bond ETFs and smart beta bond strategies. Investors may diversify a U.S.-centric portfolio with international bond ETF exposure. Additionally, given the rising rate environment ahead, some are looking into smart beta bond ETFs that may better hedge market risks and still maintain upside potential.
“We see fixed income investors looking beyond domestic to global markets for diversification purposes, making efficient currency hedging important,” Brownlie said.
“Investors are continuing to look at fixed income smart beta strategies,” she added.
For more information on the fixed-income market, visit our Fixed Income Channel.