Bond ETFs have been gathering strong flows
Despite continued preference among investors for equity markets, bond ETFs have been gathering strong flows across the globe, with UK government bonds emerging as the only major losers in recent days.
TrackInsight data shows that Developed Investment Grade Bond ETFs took in some €1.7bn over the week to 26 May, while the beginning of June saw a continuation of the trend, with developed market bond indices seeing inflows of €1.35bn on Friday 2 June. This brings total inflows into bonds so far this year to €31bn.
UK bonds have been the only outlier, suffering €37.5m of withdrawals on Friday 2 June, though overall UK Bond ETFs have seen cumulative inflows of nearly €5bn year-to-date.
The inflows into fixed income instruments come despite the fact the US Federal Reserve has begun a path of monetary policy tightening, and expectations still high for another rate hike at its June policy meeting, while there is speculation about when the European Central Bank (ECB) will tighten its aggressively loose monetary policy.
A number of recent reports have suggested that investors have particularly increased their use of bond ETFs relative to active funds. For example, a study conducted by Cerulli Associates together with BlackRock, which surveyed 378 financial advisers in the US, found they were increasingly using bond ETFs in portfolios.
Several reasons behind this growing demand for bond ETFs
The growing demand for bond ETFs has no doubt been fueled by the increasing number of products on offer, as well as the development of smart-beta bond ETFs, which are offering investors a new way to play the current environment.
For decades, simply buying a bond fund and holding it worked for investors as the asset class enjoyed a long-lasting bull market, but fears are now rising that this environment may be coming to an end, so investors are looking for alternatives to traditional bond exposure in an attempt to shelter portfolios from potential losses.
Another reason may be cost, as many ETFs will be cheaper than active products, though the cost of fixed income ETFs varies widely depending on the index they track. For example, among the nine funds with a five-star rating from TrackInsight, the OCF ranges from 0.14% for the AMUNDI ETF GOVT BOND EUROMTS BROAD INVESTMENT GRADE 3-5 UCITS ETF to 0.60% for the iShares US High Yield Bond Index ETF (CAD-Hedged), which is available in Canada.
Lastly, the level of education among investors is improving, allowing them to make better informed decisions about ETF allocations both in equities and bonds.
Doubts still remain but bond ETFs are more liquid than the underlying asset
However, doubts still remain, and some market participants are concerned about the potential impact on the ETF market in the event that liquidity in the underlying bond market dries up. However, these fears are not new, as investors have faced a number of scares over recent years with relation to fixed income markets.
Meanwhile, experts argue that bond ETFs are more not less liquid than the underlying asset. For example, Lyxor’s head of ETF strategy for Northern Europe, Adam Laird, argues bond ETFs did not face the types of liquidity problems that property investments did after the Brexit vote last summer, and provide added advantages to the investor.
The recent strong inflows into bond ETFs come after the asset class emerged as the top-seller in 2016, with European-listed bond ETFs drawing in a net €19.1bn over 12 months, according to Thomson Reuters Lipper.