With institutional investors increasingly using fixed income exchange traded funds and doing so for a variety of reasons, ordinary investors can learn some important bond ETF lessons from the pros.
Elevated equity market volatility in October highlighted professional-level use of fixed income ETFs, including the iShares Core US Aggregate Bond ETF (NYSEArca: AGG), among others.
“Record trading volumes during October’s bout of market volatility shows how fixed income investors are increasingly utilizing bond ETFs to manage risk. The volumes also show that bond ETFs have been a positive force for stability, adding liquidity and price transparency in high velocity markets,” according to a BlackRock note.
A combination of rising interest rates, a healthy injection of government debt into the markets and other external factors has made for a more complex bond market. If the sell-offs in October portend that the decade-long bull run is over, then the environment for fixed-income investors will only get more perplexing.
“One of the major forces driving the move to ETFs is the evolution of the bond market since the financial crisis,” said BlackRock in a note out Wednesday. “Heightened capital requirements have made it more expensive for dealers to hold bonds in inventory. As a result, despite the growing U.S. bond market, it has become more challenging for institutional investors to source the fixed income exposures they need. Indeed, two-thirds of institutional investors have felt the impact of diminished liquidity on their investment management process.”
One of the main reasons institutional investors are gravitating to bond ETFs is efficiency. It is easier to own broad exposure than finding a single issue.
“78% of institutional investors also cited the operational efficiency of the ETF structure. Bond ETFs make it possible to gain near immediate exposure to a portfolio of securities in a single line item, without the operational costs and complications of chasing down single bonds,” according to BlackRock.