Through November, investors put $86 billion of new money into fixed-income ETFs in 2016, even as many industry observers, including CFRA, expect the Federal Reserve to resume raising interest rates in December.
One reason is that large institutional investors are increasingly using ETFs instead of individual bonds, and a recent survey gives us comfort that further adoption will persist. As this occurs, investors large and small benefit from the enhanced liquidity.
Greenwich Associates recently completed a survey of 104 U.S. institutional investors, including insurance companies, pension funds, endowments and registered investment advisors, about their use and perceptions of fixed-income ETFs. The average size of the firms surveyed was $60 billion in assets under management.
Why Institutional ETF Usage Is Growing
According to Greenwich, post-financial-crisis rules have increased capital costs for banks, causing many fixed-income dealers to respond by slashing inventories and pulling back from their traditional role as providers of secondary market liquidity.
Indeed, 97% of institutions in the study said increased difficulties in bond liquidity have forced them to consider other vehicles, such as ETFs or derivatives, instead of individual bonds to gain exposure. Overall, 30% said they would consider replacing individual bond positions with bond ETFs in the next year.
Based on a separate recently published global institutional investor study, Scott Couto, president of Fidelity Institutional Asset Management, said that "institutions are increasingly managing their portfolios in a more dynamic manner, which means they are making more investment decisions today than they have in the past."
Adjusting Credit Quality With ETFs
In the Greenwich study, approximately 40% of institutions plan to adjust their credit quality in the next year, and nearly 60% would consider using an ETF for implementation.
For example, investors might use the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) to gain access to greater credit risk through an ETF focused on bonds rated BB and B, and the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) to gain access to less credit risk through an ETF focused on bonds rated A and BBB.
LQD has been one of the more popular fixed-income ETFs, regardless of style, in the first 11 months of 2016.
| Ticker | Fund | Issuer | YTD 2016 Net Flows ($M) |
| SPY | SPDR S&P 500 ETF Trust | SSGA | 11,556.00 |
| AGG | iShares Core U.S. Aggregate Bond ETF | BlackRock | 10,856.14 |
| IVV | iShares Core S&P 500 ETF | BlackRock | 10,516.54 |
| VOO | Vanguard S&P 500 Index Fund | Vanguard | 10,338.40 |
| GLD | SPDR Gold Trust | SSGA | 9,614.23 |
| VEA | Vanguard FTSE Developed Markets ETF | Vanguard | 8,942.43 |
| TIP | iShares TIPS Bond ETF | BlackRock | 6,743.37 |
| IEMG | iShares Core MSCI Emerging Markets ETF | BlackRock | 6,498.14 |
| VWO | Vanguard FTSE Emerging Markets ETF | Vanguard | 6,320.37 |
| LQD | iShares iBoxx $ Investment Grade Corporate Bond ETF | BlackRock | 5,076.67 |
Source: FactSet Research Systems
