Key takeaway: Using retirement target funds as a proxy for the asset allocation mix of an increasing share of our aging population, the need for income will increase and spur investment in bond-related strategies.
Interestingly, we have started to see Retirement mutual funds, as well as other asset allocation strategy types, hold ETFs rather than other mutual funds due to ETFs’ lower total cost of ownership (TCO) and ability to offset fees by lending out the underlying ETFs –something that cannot be done with a mutual fund.
The other important trend is an uptick in adoption of ETFs by insurance companies. Through the first half of 2019, insurance companies traded $16.7 billion of fixed income ETFs –essentially the same amount traded for all 2018, with assets jumping by 34%, per S&P Global Market Intelligence Data, to nearly $10 billion in aggregate.
This increase was driven by regulation changes centered on creating the bond-like statutory accounting treatments via NAIC Designations with a process known as systemic valuation leading to the “bondification” of ETFs. Now, rather than holding 1,000 individual bond line items, an insurer can hold a bond ETF and apply the same “bond math” from a capital perspective. As a result, fixed income ETFs create operational efficiencies for large and mega insurers and enable small-and mid-sized insurers to gain economies of scale when building out portfolios to bank policyholder liabilities and surplus exposures.
Key takeaway: Regulatory changes have encouraged insurance companies to join pension funds, endowments and other institutional investors who use fixed income ETFs for tactical and strategic investment strategies –adding a new type of client to propel growth in fixed income ETFs.
Factor 4: Comfort
Given the first fixed income ETF was launched in 2002, the fixed income ETF’s wrapper and operational workflow has been tested through numerous market events and has consistently enabled investors to express market views with efficiency, flexibility, liquidity—and confidence.
Still, myths persist, among them that fixed income ETFs may not be sufficiently liquid during market downturns or that growing AUM will impair price discovery. However, as we have seen in recent years, trading volume on fixed income ETFs has increased during the most volatile periods. And fixed income ETFs still only represent a small portion of overall investable assets, making up just 2% of the Bloomberg Barclays Multiverse Index total market capitalization.