Fifteen years ago this week the first bond exchange-traded funds (ETFs) debuted, changing the way investors can access fixed income markets. Today there are more than 852 bond ETFs in the US with more than US$723.77 billion in total asset under management, offering entry into almost every sector of the bond market.
What brought about this exceptional growth? Quite simply, ETFs have modernized fixed income markets.
According to BlackRock’s ETP (Exchange Traded Product) Landscape report issued in June 2017, ETF-dominated global ETPs reached a record US$332.4 billion net inflows in the first six months of the year, more than double that in the same period last year. Despite 2017 being a year in which equities have dominated allocation, fixed income ETFs have continued to gain traction, with net inflows during the period reaching US$111 billion, pointing to the versatility of ETFs and an underlying trend of investors adopting them for income in their portfolios.
Wide range of benefits
Fixed income ETFs can help make it easier for both retail and institutional investors to invest in bonds, potentially gain liquidity and add specific exposures to portfolios. Traditionally, the over-the-counter nature of the bond market favored larger, more sophisticated investors—size and scale mattered in everything from trade execution to getting allocations for new issues. Bond ETFs help level the playing field. They enable investors to efficiently access fixed income markets on demand.
With a single ticker, an investor can tap into thousands of bonds in a specific sector without having to hunt for inventory or navigate multiple offers from multiple brokers. Bond ETFs have democratized access to this marketplace. An individual investor in Kansas can trade bond ETFs on a stock exchange in the same way as a hedge fund manager in New York would.
Bond ETFs can help add incremental liquidity to the bond markets by allowing investors to trade shares on an exchange. Investors are effectively trading portfolios of bonds at a visible price on the exchange, and most of these transactions do not involve any actual bonds being traded. Bond ETFs allow investors to access bonds the same way they can access stocks.
Before ETFs, many investors relied on active mutual funds or individual securities for access to the bond market. They had to know the ins and outs of security selection (e.g. credit research, issuer analysis), or find an active manager with their same view on the market.
Now investors can use bond ETFs to build model portfolios, follow asset allocation guidance, or express their own tactical views, all in a low-cost manner.
Bond ETFs have put investors back in the driver’s seat. An investor can take control of their portfolio risk by using bond ETFs that seek to track an index. For example, investors seeking exposure to investment grade bonds know that an index tracking investment grade bond ETF will likely only hold these bonds, and won’t actively dip into high-yield securities. Investors know what they are invested in—and what they won’t be invested in down the road.
With 15 years of history, bond ETFs have mostly weathered the global financial crisis, quantitative easing and several rounds of interest rate hikes. Even with the US$700 billion in assets today, bond ETFs represent less than 1 percent of the global bond markets . If the growth in equity ETFs were any indication, bond ETFs could probably continue to grow at double digits and reach US$2 trillion in the next 15 years.
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