'Demand Has Swelled': Why Bond ETFs Will Continue Growing

The iShares Core U.S. Aggregate Bond ETF AGG, the largest U.S.-listed fixed income exchange traded fund, reached its 15^th birthday Sept. 22, making it an appropriate time to examine the bond ETF boom.

When AGG debuted, a scant number of bond ETFs were on the market. Today, more than 1,200 such funds with $840 billion in assets under management are listed around the world, according to BlackRock.

What Happened

Various data points indicate the growth of bond ETFs will continue.

“Though fixed income offerings represent 17 percent of the exchange traded product market, the category’s $63 billion of net inflows year-to-date through Sept. 7 were a 36-percent share,” CFRA Research Director of ETF & Mutual Fund Research Todd Rosenbluth said in a recent note.

“Despite recent interest rate hikes (as well expectations for additional hikes in the future), demand has swelled for low-cost, liquid vehicles for core and tactical bond allocations.”

As of Aug. 31, investors have added $51.5 billion to U.S.-listed bond ETFs this year. Bond ETFs still represent a small percentage of the overall fixed income space, but institutional investors are increasingly turning to these products as avenues for superior liquidity.

A recent survey by Greenwich Associates said institutional investors find it harder to execute large trades in some individual bonds, a scenario that is stoking demand for bond ETFs.

Why It's Important

Broadly speaking, bond ETFs do offer valid alternatives for liquidity-seeking investors. CFRA's coverage universe includes 63 bond ETFs with average daily volume of 250,000 shares or more and 138 bond ETFs with bid/ask spreads of 3 cents or less, Rosenbluth said. 

AGG is one of the ETFs meeting both parameters, as is the iShares iBoxx $ Investment Grade Corporate Bond ETF LQD and the iShares MBS ETF MBB.

Insurance companies are expected to increase usage of bond ETFs in the years ahead.

What's Next

Last year, the National Association of Insurance Commissioners revised its accounting methodology for bond ETFs, opening the door for insurance companies to increase use of these products in investment portfolios.

“A new systematic valuation method allowed insurers to treat ETFs more like ordinary bonds, which has the potential to reduce the volatility in the company's balance sheet and income statement,” Rosenbluth said. “In 2017, insurance companies increased their assets in fixed income ETFs by a whopping 69 percent, according to S&P Global.”

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