The global bond ETF industry has gone from strength to strength so far this year in terms of inflows despite anticipated interest rate hikes in the US.
Global bond passive funds gained a total of $44.5 billion in the first quarter of 2017, a new record, compared to a high of $42.5 billion in the same period last year, found BlackRock.
Hikes don’t scare investors
The news comes after Federal Reserve Chair Janet Yellen decided to raise interest rates in the US in mid-March for the third time since the 2008 credit crisis and the second time in three months, dragging the base rate from 0.75% to 1%.
(Although the rate has hovered near zero for almost a decade, medium-term investors will remember the US base rate was above 6% at the height of the tech bubble in 2000.)
The US has a 2% inflation target level. Yellen said the Fed was prepared to continue raising rates several times in 2017 to keep inflation at bay and has set aside concerns about the impact the hikes would have on consumer spending. Core and headline inflation has headed sharply upwards since US President Donald Trump was elected in November, with both rising to above 2%.
Despite a hike in interest rates, inflows to US investment grade credit saw strong demand due to positive economic data, with $14.4 billion inflows to related ETFs over the first quarter.
Investors also favoured protecting their portfolios from inflation, by investing $3.6 billion into Treasury Inflation Protected Securities ETFs in the same period.
Bonds remain key for portfolio construction
No matter central bank policy, bonds remain a crucial part of a diversified portfolio. If investors are concerned about interest rates, short-dated debt ETFs are preferable as the underlying bonds are less sensitive to hikes.
The Vanguard Short-Term Bond Index Fund (BSV) has over $21 billion under management and costs just 0.09%. Another cheap, liquid option for short-term, corporate investment grade debt is the Vanguard Short-Term Corporate Bond Index Fund (VCSH) for 0.07% fees.
US investors would be advised to choose bond ETFs that are well diversified, relatively cheap and liquid.
A fund that covers the whole fixed income market in the US is the $898 million iShares Core Total USD Bond Market ETF (IUSB) for 0.08%.
