14 August 2018
The market for bond ETFs has allowed investors to easily enter the fixed income market without going through the OTC market. Photo:
The market for bond ETFs has allowed investors to easily enter the fixed income market without going through the OTC market. Photo:

How fixed income ETFs impact the bond markets

Fixed income ETFs have seen exponential growth for more than a decade. Aside from bringing stable income and cost efficiency to both retail and institutional investors, the biggest driver behind such phenomenal growth is the fact that ETFs have modernized the fixed income market and also democratized the way in which investors gain exposures to fixed income instruments.

Since their debut 15 years ago, fixed income ETFs have changed the way that investors access the fixed income market. Investors cannot only gain exposures to different bonds in different regions, but can also achieve investment diversification and cost efficiency at the same time – all by just investing in one single ETF.

Innovative investment tool

Back in the days when smartphones were not prevalent, we needed different kinds of equipment to perform our daily tasks: from a computer, telephone, camera, recorder to a calendar. With the advancement in technology, all we need is a smartphone to go online, communicate with people, take photos, record audio clips, listen to music, etc.

By the same token, ETFs are innovative financial instruments that have multiple benefits and this feature is particularly apparent in fixed income ETFs (bond ETFs). For instance, the additional layer of liquidity.

The additional layer of liquidity offered by bond ETFs is a major reason which has driven remarkable the growth of this market. Traditional bonds are mostly traded over-the-counter (OTC), the segment of which is difficult for retail investors to enter and favors larger and more sophisticated investors. Size and scale mattered — from trade execution to getting allocations for new issues — investors would need a high level of financial knowledge to fully comprehend the underlying cost and mechanism when trading individual bonds.

However, trading on the exchange creates liquidity and allows for bond ETFs to be used to manage risk and adjust market exposures. Instead of trading one single bond in the OTC market, investors are effectively trading a portfolio of bonds at a visible and transparent price on the exchange and thus diversifying investors’ portfolios, meaning that they are trading bonds exactly like stocks.

Obtaining precision exposures with ETFs

Bond ETFs also enable investors to gain precision exposures within the fixed income market. Before the emergence of ETFs, many investors relied on active mutual funds or individual securities to access such a market and that investors did not only have to know the ins and outs of the desired security, but they also had to find active fund managers who shared similar investment philosophies as they did.

However, with bond ETFs, investors can construct their portfolios, follow asset allocation guidance, or express their own tactical or strategic views in a low-cost and efficient manner. Nonetheless, an investor can better manage their portfolio risk in the sense that investors seeking exposures to high-yield bonds know that the equivalent ETF will only hold these assets in the underlying basket. Investors know what they are invested in — and what they would not be.

The market for bond ETFs has grown for more than 15 years and allowed investors to easily dip a toe in the fixed income market without going through the OTC market — providing a more cost efficient channel for investors making bond investments. All in all, this will further facilitate the further development and popularity of such a market and we may possibly see continued growth of bond ETFs in coming years.

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Head of iShares and Index Investing Asia Pacific

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