Institutions turning to ETFs for bond market liquidity

Sep 25th, 2018 | By | Category: Fixed Income

Diminished liquidity in global bond markets is fuelling demand for fixed income ETFs among institutional investors in Europe and the United States, according to the results of a survey by Greenwich Associates.

Institutions turn to ETFs for bond market liquidity

Andrew McCollum, Managing Director at Greenwich Associates.

The goal of the survey was to understand trends impacting the fixed income investment landscape and the evolution of fixed income ETFs.

The survey involved interviews with 87 institutions in the United States and Europe that currently utilize bond ETFs in their portfolios. Respondents included investment managers, insurers, institutional funds, and (in the United States) registered investment advisors (RIAs).

A large majority of respondents noted that they increasingly face challenges in trading, liquidity and security sourcing in traditional bond markets, prompting about 60% to consider bond ETFs as an alternative vehicle for fixed income exposure.

According to Greenwich, the current liquidity issues in bond markets are a function of increased bank capital requirements put in place post the financial crisis. Heightened capital reserves make it more expensive for banks to hold the large inventories of bonds needed to act as market makers. These increased expenses and other new rules have forced banks to slash their inventories and pull back from their prior role of broad fixed income market liquidity providers.

Investors’ need for new sources of liquidity has helped drive the rapid expansion of bond ETFs within institutional portfolios. Sixty percent of institutions have increased their use of bond ETFs in the past three years, according to the survey, with allocations now averaging roughly 18% of total fixed income assets.

More than half of current users now hold at least four bond ETFs in their portfolios. Thirty percent of US survey participants have executed a single ETF bond trade of at least $50 million, including 14% of institutions that report completing a single trade of more than $100 million.

“A majority of institutions around the world now consider bond ETFs as an alternative vehicle for fixed income exposure and liquidity,” said Andrew McCollum, Managing Director, Greenwich Associates.

Institutions that have stepped up their use of the funds emphasise the utility and versatility of bond ETFs as a portfolio tool, employing them to obtain narrow and broad exposures in both high-level strategic functions and targeted, tactical applications.

Looking ahead, one-third of institutional investors plan to increase bond ETF allocations over the next 12 months, with European institutions planning to boost ETF allocations an average of 19% and US institutions targeting increases of almost 30%.

“Based on those results and investors’ continued concerns about bond market liquidity, Greenwich Associates expects steady and perhaps even accelerating growth in bond ETF usage and investment among US and European institutions for the next three to five years,” added McCollum.

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