While tariffs and trade disputes have slowed asset gathering for equity exchange-traded funds this year, lower interest rates and a strong U.S. dollar have helped fixed-income ETFs continue apace.
Through June 13, fixed-income ETFs saw $62.6 billion of inflows, according to research firm XTF Inc., compared to $24.8 billion for equity ETFs. And, not surprisingly, 57% of those fixed-income inflows have gone to the 78 products with an expense ratio of 0.10% or less. All told, the U.S. fixed-income ETF market counts 378 offerings and $718 billion in assets under management.
"Among pensions and insurers, we've seen strong adoption for shorter maturities, and issuers are doubling down by expanding their lineups," said Todd Rosenbluth, senior director of ETF and mutual fund research at CFRA Research in New York.
According to a recent Greenwich Associates survey of U.S. institutions, including investment managers, insurance managers and other institutional investors, 60% of the institutions surveyed in 2018 reported using fixed-income ETFs, compared to 20% in 2017.
Even an earlier knock on fixed-income ETFs is clearing. The National Association of Insurance Commissioners now lists over 170 ETFs that can be reported as bonds for regulatory capital.
"We are seeing increasing usage of fixed-income ETFs by institutions," said Nicholas Savoulides, the Boston-based head of global solutions research and portfolio analytics for Invesco Ltd. "They provide cost-efficient exposure to the bond market, an easy way to introduce tactical exposures or simply as a placeholder that will later be replaced by a diversified portfolio of individual bonds."
Two particular areas of the fixed-income ETF market may deserve a second look from institutional investors, based on recent increases in assets and liquidity.
The first is the U.S. high-yield sector. It's still dominated by the $15.6 billion iShares iBoxx $ High Yield Corporate Bond ETF in both assets and trading and the $8.9 billion SPDR Barclays High Yield Bond ETF and has attracted what Princeton, N.J.-based Bloomberg LP senior ETF analyst Eric Balchunas calls "the allocators" — steady low-cost seeking investors, relative to traders, who tend to flock to liquidity regardless of fund cost.
The iShares Broad USD High Yield Corporate Bond ETF, with an expense ratio of 0.22%, has garnered $893 million of inflows year-to-date, according to XTF, while a low-cost competitor from DWS Asset Management, the Xtrackers USD High Yield Corporate Bond ETF, has seen $703 million in flows at an expense ratio of 0.2%. Their higher cost competition, while both seeing positive flows this year, have experienced large redemptions in the past several weeks as intermediate and longer term interest rates have moved back down.
The second area of interest is defined maturity ETFs. These ETFs, pools of bonds held to maturity which then dissolve after distributing the principal, are adding assets and liquidity to the point where seven of the 54 products from iShares and Invesco now top $1 billion in assets. Invesco's Mr. Souvalides, who works to help clients immunize cash flows, said that some of the off-the-shelf defined maturity products can also be used by institutions for the same purpose.
"Insurance companies are surprisingly more tactical than other institutional investors when it comes to ETF usage," said CFRA's Mr. Rosenbluth. "And the structure of the defined maturity products is effective for liability matching and risk management."
Currently, 16 of iShares 30 defined maturity ETFs have received a requested NAIC determination, while none of Invesco's twenty-four products have.
One notable challenge for the fixed-income ETF market, however, is one that it has less control over.
Credit quality in large, broad-based corporate debt indexes has begun to degrade, with 48.9% of the holdings in the $33.4 billion iShares iBoxx $ Investment Grade Corporate Bond ETF at BBB, according to BlackRock Inc., and 57.7% of the holdings in the $25 billion Vanguard Intermediate-Term Corporate Bond ETF at Baa, according to Vanguard.
A recent research note from Neuberger Berman, however, points out that 60% of the growth in the BBB market since June 2018 has come from five large downgraded issuers in the past year.
"While we believe that a majority of the large-cap BBB companies will be able to maintain their ratings, through the cycle, we have seen a preference for some investors to move up in quality," said Jonathan Rather, vice president of fixed-income strategy at BlackRock In New York. For example, the $343 million iShares AAA-a Rated Corporate Bond ETF has gathered 35.6% of its total assets since the beginning of the year.