The fixed-income markets are notoriously known for their illiquid securities. However, more investors are increasingly looking to bond-related ETFs as a quick and easy way to gain broad exposure to debt markets.
While fixed-income ETF assets account for less than 1% of the value of outstanding bounds globally, a number of factors have contributed to a rising demand for bond-related ETFs.
For instance, regulatory reforms enacted after the financial crisis have led to significant reduction in inventories of debt held by broker-dealers and banks, the Financial Times reports. Meanwhile, corporate debt issues have increased significantly as companies took advantage of lower rates.
Eric Wiegand, head of ETF strategy at DWS, pointed out that the expanded corporate bond market is very fragmented, with a range of credit profiles and maturities. “Meanwhile, the role of banks and brokers as a facilitator of trades has shrunk. So it is more difficult for institutional investors to trade large portfolios of bonds,” Wiegand told the Financial Times.
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Consequently, more investors have turned to fixed-income ETFs, especially among institutional level investors. According to a Greenwich Associates survey of 120 European institutional investors, 45% of respondents used bond ETFs in 2017, compared to 38% in 2016. The increased interest has also helped improve liquidity in the ETF market, making it easier for investors to execute large trade orders.
“It is now possible to efficiently trade $100m in a corporate or emerging markets bond ETF in a single transaction. That was not possible even just a few years ago. We expect to see more investors gravitate towards fixed income ETFs,” Wiegand said.
ETFs have also become a go-to tool that traders use during more volatile conditions as ETFs often exhibit deeper pools of liquidity than their underlying debt securities. For instance, U.S. high-yield bond ETFs were tested during a stressful period in late 2015 when Third Avenue management unexpectedly blocked investor withdrawals from its high-yield mutual fund.
“Investors moved into the liquid instruments, ETFs, even as the signs of stress in the underlying bonds rose,” Wiegand said, adding “ETFs became the vehicle for price discovery in the high-yield market during that period of volatility.”
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Furthermore, the low-costs and efficient structure associated with the ETF wrapper has also attracted many more institutional investors in recent years.
“The largest inflows we have seen have come from investors who are no longer willing to pay annual management fees of 50 to 75 basis points for an actively managed bond fund when its is possible to buy sovereign bond ETFs for less than 10 bps,” Adam Laird, head of ETF strategy in northern Europe for Lyxor, told the Financial Times.
Given the rising interest in bond ETFs among larger investors, BlackRock projected that global ETF assets could hit $12 trillion by 2023, with fixed-income ETFs accounting for $4 trillion over the next five years.
For more information on the fixed-income space, visit our bond ETFs category.