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Why Invest in Fixed Income ETFs

Global fixed income exchange traded fund (ETF) assets have increased to more than $1.5 trillion.1 This steady growth has created a more centralized and transparent fixed income marketplace. And Cerulli Associates expects ETF assets to continue to grow as advisors increase their ETF allocations, retail investors become familiar with the vehicle and product suites expand. 2


July 2021


More Than a Decade of Fixed Income ETF Growth

Benefits of Fixed Income ETFs

ETFs’ unique characteristics enable investors to:

Lower Costs US-listed fixed income ETFs have a median expense ratio of 0.28%, versus mutual funds’ 0.64%. While many ETFs are index based, this lower-cost profile carries over to actively managed ETFs that have a median expense ratio of 0.40%, versus 0.65% for actively managed bond mutual fund strategies.3

The ETF structural advantages can be pronounced when compared to a single security or individual bond exposure. With individual bonds, broker-dealers collect commissions on bonds they sell or buy through markups and markdowns, which are bundled into the quoted price to investors on both sides of the transaction. When an investor buys a bond, the dealer marks up the price of the bond above its face value. When an investor sells, the dealer will mark down the price of the bond and pay less than its current value. These transaction costs usually range from 1%–5% of the bond’s original value; however, they vary based on order size, issue or broker. Regulations now require bond dealers to publish their markups and markdowns on certain types of bonds on trade confirmations, which means after the transaction occurs.

Improve Liquidity ETFs' robust secondary market allows investors to tap into market liquidity more easily than they can with single-CUSIP bond holdings. This enables them to reallocate portfolios quickly across asset classes or meet investor redemptions by selling an ETF position into the market without having to sell single-CUSIP bonds. Fixed income ETFs are also more liquid than mutual funds, as ETFs trade intraday and mutual funds are typically transacted end of day.

Increase Transparency Both index-based and actively managed ETFs report holdings daily, increasing transparency for investors performing daily portfolio due diligence and attribution for risk management.
Mutual funds report their holdings less frequently — typically, quarterly. That means any allocation changes in a bond mutual fund could take place months before shareholders are aware of them.

Target Duration ETFs precisely cover the entire term structure along the yield curve, so investors can fine tune a portfolio’s interest rate risk (duration) to match market views or client liabilities.

Modulate Credit Risk Ranging from investment-grade credit to crossover debt to senior loans to high yield, ETFs allow investors to control the amount of credit risk in a portfolio with ease and transparency.

Strategic and Tactical Uses

Launched in 2002, fixed income ETFs gained traction after the financial crisis. Price and holdings transparency and ease of trading drove that growth as many dealers reduced their balance sheets and transitioned from principal- to agency-based trading models in cash bonds.

Fixed Income ETFs allow you to:

Be Active with an Index Using the vast array of ETFs to optimize portfolios for precise yield, duration, spread, and sector, or even to naively reweight sectors of the Bloomberg Barclays U.S. Aggregate Index, investors can create custom portfolios across a wide array of bond subsectors.

Seek Active Management More than 150 actively managed bond ETFs have launched in the US over the past 10 years and now have more than $111 billion of AUM. Some of these ETFs have 3-, 5- or 10-year track records.4

Replicate Beta The expansion of liquid ETF products supports more adaptable beta solutions to equitize cash or provide easy reinvestment of accumulated coupon payments.

Target Trends Investors can seek alpha by rotating efficiently in and out of asset classes based on macro, technical or fundamental trends. For example, investors can rotate into emerging market local debt in a declining rate and softer dollar environment. Or they can short ETFs to make relative value trades, such as loans over high yield, by executing on just two CUSIPs.

Additional Portfolio Uses

ETFs’ in-kind creation/redemption process also supports their use in a variety of other portfolio roles:

Transfer of Assets The breadth of securities owned by ETFs allow large investors holding single bonds to leverage the in-kind creation/redemption process to efficiently transfer select underlying bonds on their books into an ETF.

Transition Management If an asset manager receives an influx of cash, index-based fixed income ETFs can be used as temporary placeholders to obtain exposure while searching for a new manager. When a new strategy is decided on, investors working through an AP can redeem out of the ETF and take delivery of the individual bonds through the redemption process.

Inventory Consolidation Sell-side brokerage firms can use fixed income ETFs to manage the inventory held by their trading desks, consolidating positions across traders, and move bonds off their books by creating ETF shares that they can then sell in the market.

Derivative Alternatives
Fixed income ETFs provide alternatives to total return swap and credit default swap indices.

Also, investors can tap into over $80 billion of ETF option notional value open interest on fixed income products for risk mitigation, income generation or more advanced strategies.5

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