Over the last few years, shifts in global central banks’ monetary policies have provided fixed income investors with a number of challenges. For example, following the global financial crisis, ultra-low rates and fixed income returns drove demand into higher yielding assets, partly in the form of longer duration and riskier credit plays.
As markets develop, investors may seek to shift their fixed income strategy to a shorter duration and a move up in credit quality.
In order to ensure specified targets are met, fixed income investors could consider a strategy that provides them with flexibility and allows them to easily tweak portfolio duration and credit exposure to respond to dynamic markets.
Managing fixed income index strategies
Amount in indexed fixed income assets 1
Dedicated Portfolio Managers and Trading Desks
The ability to quickly take a position has proved to be one of the most attractive features of exchange traded funds (ETFs). As a result, fixed income ETFs provide an efficient vehicle to adjust duration and credit exposure.
For example, investors looking to prepare for rising rates may want to seek to lower portfolio duration. There are numerous low-cost ETFs tracking indices that measure the performance of delimited maturity segments of government and corporate bond markets, such as 0-1 or 1-3 years. A reallocation of a portion of the capital to an ETF providing exposure to the 0-1 year maturity bracket would reduce portfolio duration and the downside to bond prices in the event of rising rates. Maturity-segmented ETFs can be used to tilt the duration of a portfolio and also allow for multiple duration combinations to suit specific risk and return objectives.
A Wide Range of Fixed Income ETFs
The fixed income ETF market, which was launched in 2002, is still relatively young. Globally fixed income ETFs have grown notably since and currently comprise 10.2% of the global fund market with USD$800 billion in assets.2 The wide range of fixed income ETFs available means that investors can overlay their portfolio, making subtle moves in duration, credit quality, or currency exposure easily.
Investors also use ETFs to fine-tune asset allocations to adapt to changing markets. This strategy is known as tactical asset allocation, and it can provide investors with flexibility and short term planning within a long term strategy.
Fed Tightening Prompts ETF Usage
Between October and December 2018, a new US ETFs survey from Greenwich Associates canvassed 181 institutional investors, including 37 institutional funds, 33 insurance companies/insurance company asset managers, 56 registered investment advisors and 11 investment consultants.
The study highlights that US institutions have adopted ETFs as a mainstream and even primary means of taking on investment exposures in fixed income portfolios. 60% of study participants invest in bond ETFs—up from 20% as recently as 2017. Average ETF allocations rose notably to approximately 29% of total fixed income assets in 2018 from 20% in 2017.
The relatively rapid adoption of fixed income ETFs has been driven in part by changing market conditions. More recently, tightening by the US Federal Reserve (Fed) has forced investors to reposition fixed income portfolios for the rising rate environment. ETFs are one of the main tools being used in implementing these adjustments.
Study participants also noted that ETFs provide several important benefits over other vehicles when making these changes. In fact, as usage rates increased last year, so too did the share of study respondents citing ETF benefits such as low management fees and ease of use as reasons for using bond ETFs. 87% of portfolio managers and chief investment officers see quick access as a primary benefit to investing in bond ETFs.
We launched the industry’s first US-listed ETF in 1993 as a cash equitisation vehicle for institutional investors. Since then, institutions remain some of the largest investors in ETFs, with usage continuing to expand across a wider range of investors and investment strategies.
ETFs offer investors further benefits – they are low cost, simple, tax efficient and easy-to-access investments.
Providing unique insight into the fixed income market via a snapshot of both fixed income flows and holdings indicators, extracted from a wider data set that represents $10 trillion of assets, and PriceStats®, an innovative inflation tool tracking daily price changes of millions of online items.
1 As of 30 June 2019. Source: BIG (Fund View). Total Assets Under Management (AUM) is stated in USD and is for Fixed Income assets managed by the Fixed Income Beta Solutions team only, exclusive of all cash and securities lending assets and fixed income portfolios managed by ISG. All calculations are unaudited. Other includes: indexing accounts with large degrees of customisation, Convertible, Securitised and Municipal Indexing Strategies. Fixed Income Indexing AUM of US$394 bn is equivalent to: EUR 347 bn; GBP 310 bn ; CHF 385 (based on Bloomberg FX data as at date shown).
ETFs managed by State Street Global Advisors have the oldest inception dates within the US, Hong Kong, Australia, and Singapore. State Street Global Advisors launched the first ETF in the US on January 22, 1993; launched the first ETF in Hong Kong on November 11, 1999; launched the first ETF in Australia on August 24, 2001; and launched the first ETF in Singapore on April 11, 2002.