There's A Lot Of Love For Bond ETFs

As has been widely documented, the fixed income space represents a significant growth opportunity for sponsors of exchange-traded funds.

This year, investors have added over $60 billion to bond ETFs. On a combined basis, more than 20 percent of that total has flowed into the iShares IBoxx $ Invest Grade Corp Bd Fd LQD and the iShares JPMorgan USD Emer Mkt Bnd Fd ETF EMB, making those ETFs two of the top 10 ETFs in terms of new assets added this year. EMB is the largest emerging markets bond fund in the world, ETF or mutual fund, while LQD is the biggest corporate bond ETF.

Importantly, financial advisors and institutional investors are displaying preferences for bond ETFs for multiple reasons.

“Most advisors got started with ETFs by buying equity or commodity funds,” said BlackRock in a recent note. “Only 3.5 percent of advisors bought a bond ETF as their first trade. However, those advisors who are using ETFs have come to recognize that bond ETFs offer many of the same benefits as an equity ETF, including diversification, low fees and ease of exposure.”

Positive Data

Bond ETFs account for less than 20 percent of all ETF assets, implying plenty of room for growth. Importantly, advisors are increasingly comfortable allocating to bond ETFs and are doing so at the expense of higher fee fixed income mutual funds.

“U.S. bond ETF assets have grown from $20.5 billion in 2006 to approximately $447 billion as of year-end 2016, representing a compound annual growth rate of 36 percent," said Cerulli Associates. "While assets have grown substantially over the past decade, bond ETFs still only represent a fraction (18 percent) of the $2.53 trillion ETF market. Equity ETFs account for $1.5 trillion, roughly 3.5 times the size of the bond ETF market. However, in 2016, a record $93 billion of inflows came from bond ETFs, representing 32 percent of all U.S. ETF flows. The growth of bond ETFs sheds some light on the ongoing trend among advisors, as more turn to new ways to gain liquid and transparent exposure in the bond market."

Liquidity is one reason why many traders have turned away from individual junk bonds and now rely on ETFs such as the iShares iBoxx $ High Yid Corp Bond HYG for exposure to the high-yield bond market.

Catalysts For Bond ETF Growth

Some regulatory catalysts could foster further bond ETF growth.

“The Department of Labor (DOL) Fiduciary Rule plays a role here. As you pointed out earlier, the inflow so far in 2017 has been significant, and according to data on net new assets, the flows into bond ETFs this year are on pace to exceed last year,” said BlackRock.

Additionally, a recent regulatory change by the National Association of Insurance Commissioners regarding the treatment of bond ETFs could stoked increased usage of these funds in insurance providers' investment portfolios.