Insurers Buy Bond ETFs Before Fed

Key Takeaways

• Insurance companies were net buyers of fixed income ETFs throughout the volatile first quarter. The $3.4 billion purchased in the asset category was five times the activity for equity ETFs.
• More than $2 billion worth of the iShares iBoxx USD Investment Grade Corporate Bond ETF (LQD) was purchased in the first three months by these institutional investors, with 83% occurring before the Federal Reserve announced plans to buy ETFs.
• The Vanguard S&P 500 ETF (VOO) was more popular to purchase than the SPDR S&P 500 ETF Trust (SPY) despite lower overall average volume.

Insurance companies were net buyers of fixed income ETFs throughout the first quarter. According to an S&P Dow Jones report titled “ETF Transactions by U.S. Insurers in Q1 2020,” insurance companies bought $3.4 billion (net purchases) of fixed income ETFs in the first three months of 2020. The more than $3 billion was five times the amount the insurance industry bought of equity ETFs ($0.6 billion) during a volatile period.

In March, insurers continued purchasing fixed income ETFs, but sold equity funds. Insurance company assets invested in ETFs reached $31 billion at the end of 2019, more than doubling in the last five years. Though ETFs represented just 0.5% of admitted assets, 35% of insurers used ETFs in 2019, leaving significant room for growth.

Raghu Ramachandran, head of the Insurance Asset Channel as S&P Dow Jones Indices, analyzed first quarter insurance company transactions using National Association of Insurance Commissioners (NAIC) data available on the S&P Global Market Intelligence platform. He found $25 billion of transactions, 58% that were purchases.

Although property and casualty companies hold the most ETFs in the insurance industry, Ramachandran noted the life insurance companies, particularly the larger ones, were more actively buying ETFs in the first quarter. In the first three months of 2020, corporate bond ETFs comprised 85% of the net shares purchased within the fixed income category, while Treasury ETFs experienced modest selling pressure.

To read the full S&P Dow Jones report visit https://www.spglobal.com/spdji/en/research/article/etf-transactions-by-us-insurers-in-q1-2020/

Net purchases of ETFs do not directly lead to a product’s asset growth, as insurance company ETF buying in the secondary market might have occurred as other investors sold fund shares.

LQD dominated insurance company activity in the first quarter. While four of the five most popular ETFs to add to were fixed income, LQD incurred the strongest interest. The investment-grade corporate bond fund had net purchases totaling $2.1 billion in the first three months of 2020, with $1.5 billion (72%) alone in March. This came following a 31% reduction of LQD shares held in the 12 months ended December 2019.

Meanwhile, the more credit-sensitive iShares iBoxx USD High Yield Corporate Bond ETF (HYG) was second, with $572 million, with 76% of net buying occurring in January and only modest purchases in March. In contrast, the high-yield peer SPDR Bloomberg Barclays High Yield Bond ETF (JNK) and the ultra-short term iShares Short Maturity Bond ETF (NEAR) incurred $312 million and $246 million, respectively, of favorable trading activity in the first quarter, with 76% and 99%, respectively, occurring in March.

We think insurers found the liquidity of fixed income ETFs appealing relative to accessing the cash bond market, as credit spreads widened amid elevated default risk and bond sellers outweighing buyers in March. ETFs also provide diversification and price discovery benefits relative to individual bonds. Greater usage by institutional investors, such as insurance companies, helps all investors have confidence that trades will be executed at close to the fund’s net asset value.

Largest ETF Purchases by Insurers in Q1

Source: NAIC via S&P Global Market Intelligence, as of March 31, 2020

The Federal Reserve provided a limited first quarter boost to insurance demand for LQD. As the credit market dried up due to the initial impact of COVID-19, the Federal Reserve sought to provide stability of the financial system. On March 23, the Fed announced unprecedented efforts to support corporate bonds, found in many popular bond ETFs, as well as plans to purchase the ETFs directly.

Though the Fed’s buying of ETFs did not start until May, net inflows to fixed income ETFs initially climbed in March, with many people believing that investor front-running of the Fed was a key driver. This was not evident in analysis of first quarter insurance company trading activity.

LQD Net Purchases by Insurers in March ($M)

Source: NAIC via S&P Global Market Intelligence, as of March 31, 2020

LQD’s three best days for net purchases in March occurred before the Fed announced plans to purchase fixed income ETFs—$309 million on March 18, $241 million on March 13, and $237 million on March 20—suggesting that insurance companies found the liquidity the fixed income ETFs provided appealing in light of market volatility. Overall, 83% of the net purchases in the first quarter occurred before March 23. Meanwhile, insurance companies had zero net purchases between March 25 and March 29.

Buying activity in March was concentrated to a few insurers. Just three life insurance groups—Northwestern Mutual, John Hancock and Allianz—bought $1.2 billion of LQD. For perspective, the Fed purchased $1.8 billion of LQD between mid-May and mid-June, though fewer people know about the insurance company activity.

Low cost VOO is not just appealing to retail ETF investors. Turning to equity ETFs, in the first quarter of 2020, VOO had the lowest expense ratio among the three popular S&P 500 Index-based ETFs, though the iShares Core S&P 500 ETF (IVV) matched it in June. This made VOO compelling to self-directed investors and advisors who prioritize fund fees, even as VOO’s daily trading volume is lower than other similarly constructed ETFs.

However, VOO’s net buying activity by insurers totaled $302 million, higher than IVV’s $238 million and SPY’s $41 million. VOO’s purchase activity was the most consistent of the trio of funds during the first quarter, with the second-most selling in January and March and the second-most buying in February.

SPY was the product of choice, with $104 million of net purchases, in contrast to net selling for VOO (-$65 million) and IVV (-$579 million), as a bear market emerged for U.S. equities in March.

Insurance Demand for S&P 500 Index based ETFs in Early 2020 ($M)

Source: NAIC via S&P Global Market Intelligence, as of March 31, 2020

Conclusion

Insurance companies continue to gain comfort in using ETFs, but we are particularly encouraged by the adoption of fixed income ETFs and lower cost equity funds often used by retail investors. The purchase activity in fixed income also appears to be driven by recurring liquidity and price discovery benefits, and not abnormal buying by the Federal Reserve.

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