How the pros use bond ETFs

Dec 11th, 2018 | By | Category: Fixed Income

By Matthew Tucker, Head of iShares Americas Fixed Income Strategy at BlackRock.

Matthew Tucker, Head of iShares Americas Fixed Income Strategy at BlackRock.

Matthew Tucker, Head of iShares Americas Fixed Income Strategy at BlackRock.

A recent report shows that as bond markets evolve, large institutional investors are finding new ways to use ETFs. Their learnings may be helpful for smaller investors as well.

Rising rates and market uncertainty have many people taking a second look at their bond portfolios–not just sector exposures but the vehicles they use to gain those exposures. More and more, investors are moving away from individual bonds and turning to ETFs for their simplicity, low cost and diversification.

Large institutional investors have been big adopters of bond ETFs. As Greenwich Associates found in their new report, 60% of institutions in the US and Europe have increased their use of bond ETFs in the past three years, with an average allocation of 18% to their fixed income portfolios.

A changed bond universe

One of the major forces driving the move to ETFs is the evolution of the bond market since the financial crisis. Heightened capital requirements have made it more expensive for dealers to hold bonds in inventory. As a result, despite the growing US 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.

Source: BlackRock.

So how are large institutions navigating this new bond market? Enter the fixed income ETF. On the market since 2002, the structure allows investors to trade bonds on exchange, like a stock ETF, thus offering multiple layers of liquidity through primary and secondary markets.

Over three quarters (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. For example, the iShares Core US Aggregate Bond ETF (AGG US), has over 6,800 holdings and a net expense ratio of just 0.05%. Acquiring that many bonds would be unimaginable even for a large institution. Even if an investor could track down the bonds, the transaction costs would be overwhelming.

An all-purpose vehicle

With over 350 fixed income ETFs currently offered in the United States, investors are most likely able to find a fund to fit their needs. Whether for broad market exposure or niche tactical plays, the motives for using ETFs are consistent.

Source: BlackRock.

Fixed income ETFs aren’t just for big investors; they have democratized the markets for all investors by making bonds easier to access than ever before. Now anyone can invest like a professional.

(The views expressed here are those of the author and do not necessarily reflect those of ETF Strategy.)

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