The most significant money market fund reforms — floating net asset values, liquidity fees and gates — take effect in October 2016 and a pocket of the fixed-income exchange-traded fund market once expected to attract investors looking for on-demand liquidity has yet to significantly materialize.
The previous argument for this class of fixed-income ETFs — ultrashort term — was that they provided a haven for yield seekers looking to take a slightly more basis risk than a money market fund for more income. Coupled with short-term fixed-income ETFs, these products were pitched to help investors stay nimble and effectively manage a shift in short-term interest rates.
Yet with global macro concerns making the U.S. interest rate outlookless certain in terms of the pace or level of forthcoming increases, the much expected “duration rotation” of two years ago has been underwhelming. In fact, investors across the board continue to park their assets in broader fixed-income index products with no specific maturity tor traditional intermediate term.
According to research from XTF Inc., 48 ultrashort and short-term fixed-income ETFs held a total of $85 billion in assets with the 10 largest ETFs holding 80% of the assets as of July 17. In the past year, the funds have collectively seen $7.8 billion in net new money.
Funds with aggregate maturities and duration more in line with broad-based fixed-income indexes took in nearly $41 billion across a universe of 167 funds and $208 billion in assets under management. While individual fund flows are often more telling of specific investor preference, in aggregate they can indicate direction, and investors are not moving to short-term.
At $16 billion, the Vanguard Short-Term Bond ETF (BSV) is the largest of the set, costing 0.10% and yielding 1.12% with an average duration of 2.7 years. Average daily volume is 1.2 million shares at $80 per share. The $10.7 billion iShares 1-3 Year Treasury Bond ETF (SHY) turns over about 1.3 million shares daily on average at $84 per share. And the $4.2 billion SPDR Barclays Capital Short Term High Yield ETF (SJNK) does 1.6 million shares, on average, at $28.60 per share.
Compared to institutional money market funds, which held $1.7 trillion in assets as of July 15, ETFs have longer settlement periods (three days compared to one day) and are treated by some institutional investors as “equity” investments despite their underlying holdings.
The chatter around bond ETFs and fixed-income market liquidity — the subject of a boisterous dialogue between BlackRock Chief Executive Laurence D. Fink and hedge fund manager Carl Icahn — surely hasn't helped to win over skeptics of exchange-traded funds.
In fact, BlackRock in early July published two “viewpoints” designed to reiterate the house view on both topics. The firm argues that in a fixed-income market which has fundamentally changed due to electronic trading, bank capital requirements, and regulation, bond ETFs are a tool for price discovery and intraday liquidity at the fund level.
“Institutions used to the ease of transacting in size in money market funds find that most of these ETFs just don't have the liquidity,” said Todd Rosenbluth, head of mutual fund and ETF research at S&P CapitalIQ in New York. “In the products where there is enough liquidity, however, short and ultrashort fixed-income ETFs can be used in transitions with the confidence that NAV will be close to flat.”
The futures market remains a preferred outlet for exposure to interest rate shifts. For investors eyeing short-term ETFs, finding the right product requires looking beyond the title to the duration and credit quality of individual holdings published daily. Some fund prospectuses (and target benchmarks) reveal a wider-than-expected range of maturities in the underlying index or actively managed strategy.
David Mazza, State Street Global Advisors' head of ETF research in Boston, says he is beginning to see pension funds and endowments using shorter fixed-income products for duration matching against specific liabilities.
“Other tools (futures, swaps, direct investment, etc.) come with their own risks, including portfolio and collateral management,” said Mr. Mazza. “At the short end of the yield curve, an ETF can be a very simple and effective vehicle.”
Following the initial success in asset gathering by the $3.7 billion PIMCO Enhanced Short Maturity Active Fund (MINT) in 2009, an actively managed strategy with wide berth on investment-grade credits (venturing to BBB-) and target duration of no more than a year, several other ETF issuers brought competing funds to market, modulating expense ratios and targeted exposures. Only iShares Short Maturity Bond ETF (NEAR) has managed to also eclipse $1 billion in assets as well.
MINT currently yields 0.74%, with a 0.31-year duration and 0.35% expense ratio. NEAR yields 1.22%, with a 0.45-year duration and 0.25% expense ratio.