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
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
1 Source: Morningstar, as of 05/31/2021.
2 Cerulli Associates, April 21, 2021.
3 Morningstar as of 06/30/2021. Oldest share class of mutual funds used in calculation.
4 Morningstar as of 06/30/2021.
5 Bloomberg Finance, L.P. as of 06/30/2021.
Alpha A gauge of risk-adjusted outperformance that is measured relative to a benchmark because benchmarks are often considered to represent the market’s movement as a whole. The excess returns of a fund relative to the return of a benchmark index is the fund's alpha.
Bloomberg Barclays US Aggregate Bond Index A benchmark that provides a measure of the performance of the U.S. dollar denominated investment grade bond market. The Agg includes investment-grade government bonds, investment-grade corporate bonds, mortgage pass through securities, commercial mortgage backed securities and asset backed securities that are publicly for sale in the US.
Bond A debt investment in which an investor loans money to an entity — typically a corporate or governmental entity — that borrows the funds for a defined period of time at a variable or fixed interest rate. Bonds are used by companies, municipalities, states and sovereign governments to raise money and finance a variety of projects and activities. Owners of bonds are debtholders, or creditors, of the issuer.
CUSIP Stands for the Committee on Uniform Securities Identification Procedures. Formed in 1962, this committee developed a system that identifies securities, specifically U.S. and Canadian registered stocks, US government and municipal bonds, exchange-traded funds and mutual funds.
Duration A commonly used measure, expressed in years, that measures the sensitivity of the price of a bond or a fixed-income portfolio to changes in interest rates or interest-rate expectations. The greater the duration, the greater the sensitivity to interest rates changes, and vice versa. Specifically, the specific duration figure indicates, on a percentage basis, by how much a portfolio of bonds will rise or fall when interest rates shift by 1 percentage point.
Liquidity The ability to quickly buy or sell an investment in the market without impacting its price. Trading volume is a primary determinant of liquidity.
Yield The income produced by an investment, typically calculated as the interest received annually divided by the price of the investment. Yield comes from interest-bearing securities, such as bonds and dividend-paying stocks.
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ETF expenses will reduce returns. Frequent trading of ETFs could significantly increase commissions and other costs such that they may offset any savings from low fees or costs. In general, ETFs can be expected to move up or down in value with the value of the applicable index. Although ETF shares may be bought and sold on the exchange through any brokerage account, ETF shares are not individually redeemable from the Fund.
Actively managed funds may underperform its benchmarks. An investment in the fund is not appropriate for all investors and is not intended to be a complete investment program. Investing in the fund involves risks, including the risk that investors may receive little or no return on the investment or that investors may lose part or even all of the investment.
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ETFs trade like stocks, are subject to investment risk, fluctuate in market value and may trade at prices above or below the ETFs net asset value. Brokerage commissions and ETF expenses will reduce returns.
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