Bond ETF Boom Still In Early Innings

Advisors and investors are piling into fixed income exchange-traded funds this year, a trend that is expected to continue in the coming years as more institutional investors turn to bond ETFs.

Through the first half of 2016, about $40 billion flowed into bond ETFs, with approximately half of that total flowing into iShares products. In the third annual version of “Institutional Investors Embrace Bond ETFs,” BlackRock, Inc. BLK, parent company of iShares, and Greenwich Associates, showed institutional use of fixed income ETFs is expected to continue rising.

Likely due to increased regulatory burdens, 71 percent of the institutional investors surveyed in the BlackRock/Greenwich study said trading bonds is tougher today than it was three years ago. About three-quarters of respondents are altering their investment process as a result.

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Bond ETFs, such as the iShares iBoxx $ High Yid Corp Bond (ETF) HYG, have endured concerns about liquidity. However, in the case of high-yield ETFs like HYG, are arguably more liquid than meets the eye and certainly more liquid than individual junk issues due to the secondary market.

The Importance Of Secondary Markets

The secondary market for junk bonds and ETFs like HYG is vital, because during times of heightened market stress, over-the-counter, high-yield bond market liquidity can and does evaporate, forcing the bulk of trading into the largest, most liquid issues.

As was seen during the taper tantrum of 2013, the secondary market for ETFs bolsters available fixed income market liquidity and can act as an efficient price discovery mechanism for the issues held by a fund such as HYG.

“When asked why they invest in bond ETFs, 85 percent cite liquidity and 84 percent cite operational simplicity,” according to the new BlackRock study.

Other Findings: Derivatives And Futures

Data from the study indicate ETFs continue to eat into territory held by derivatives and futures as many users of bond ETFs would consider using those products in place of derivatives. That extends a theme that has seen many institutional investors switch to S&P 500 ETFs for exposure to that index over S&P 500 futures.

“Among derivative users, 88 percent say they have or would consider using bond ETFs as an alternative, citing tracking differences and operational simplicity as key reasons,” according to the study.

Increased institutional use of bond ETFs jibes with data from the "Institutional Investment in ETFs: Versatility Fuels Growth" survey published by Greenwich Associates earlier this year.

At the end of last year, data indicated U.S.-based institutional investors account for a significant percentage of U.S. ETF use. These investors currently hold 36 percent, or $756 billion of $2.1 trillion in U.S. ETF assets under management, according to the Greenwich Associates study.

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