The maturation of fixed-income ETFs has been a long time coming, and it’s only recently that they’re really taking off.
For an asset class that plays such an integral role in global capital markets and in investors’ portfolios, the options available to investors prior to 2011 were mostly broad and U.S. focused.
There are good reasons for this.
Because ETFs are mostly indexing vehicles, they need to closely track their indexes, while still being liquid enough to easily trade on an exchange. Accomplishing both of those objectives in fixed income isn’t easy, if for no other reason than that many bond issues are thinly traded.
In the real world of ETFs, that means that providing exposure to niche areas requires high levels of optimization, which, in turn, can lead to tracking error.
Nevertheless, this year we saw an explosion of internationally focused debt ETFs. With a month left in 2011, 18 international fixed-income ETFs launched in 2011. That’s more than in all prior years combined.
Previously, funds carried broad geographic scope. Leading the charge was State Street, with the SPDR Barclays Capital International Treasury Bond ETF (NYSEArca: BWX) and the SPDR DB International Government Inflation-Protected Bond ETF (NYSEArca: WIP) as the first international bond and international inflation-protected bond ETFs.
Earlier this year, the realm of international fixed-income got a shot in the arm with the launch of three ETNs targeting debt futures in individual countries. Those were the PowerShares DB German Bund Futures ETN (NYSEArca: BUNL), the PowerShares DB Italian Treasury Bond Futures ETN (NYSEArca: ITLY) and the PowerShares DB Japanese Government Bond Futures ETN (NYSEArca: JGBL).
Since then, WisdomTree, Guggenheim, PowerShares and Pimco have entered the fray, with funds targeting debt from individual countries.
Unlike the PowerShares ETNs, these funds physically hold the underlying securities. With the exception of China, these newer funds target the debt of established developed economies, including Australia, Canada, Germany and New Zealand.
This focus on bonds issued by relatively healthy developed countries is a dramatic change in focus from last year, when emerging markets were all the rage.
And it seems plain that the options available to investors may only become more plentiful.
Last week, for example, iShares filed for seven fixed-income ETFs, with significant implications for what investors can expect to come in the future.
Three of the planned iShares funds focus on corporate debt, with each targeting specific sectors. Two others will zero in on specific portions of the mortgage-backed securities market, and one will target exposure to the lowest credit risks among U.S. corporate bonds in general.
The launch of these funds would be the right step in the evolution of the bond ETF offerings.
Still, it’s important to remember that there’s a clear difference between filing for and launching funds. For example, PowerShares filed for U.S. sector bond ETFs back in 2009, and two years later, the filings remain in registration.
Within the ETF landscape, fixed income continues to be an underutilized asset class. Investors will often make specific bets when it comes to equities, but just blindly choose the broadest fixed-income fund. This stems from a lack of education about fixed income as a whole.
The increased granularity of fixed-income product offerings will provide investors with opportunities to express more nuanced opinions and increase awareness about the importance and complexity of the asset class as a whole.