Investors Falling For Bond ETFs
With apologies to John Green, investors have fallen in love with bond ETFs the way you fall asleep: Slowly, and then all at once. Last year, investors boosted their allocations to fixed-income ETFs in every category except one: international investment grade (which remained flat year-over-year):
"Growth in use of fixed-income ETFs was underway for several years. However, 2017 likely marked an inflection point in institutional use, both due to the market situation and investor comfort levels," said McCollum.
Rising interest rates, which have posed a risk for years but which finally seem to be coming to fruition, have driven much of this demand growth.
But so too has a continued liquidity crunch in the individual bond market. Dealers hold less inventory than they once did, making liquidity of individual bond issues an ever-greater concern. Liquidity of bond ETFs, meanwhile, has been accelerating, increasingly making them the default choice of fixed-income investors.
Like with futures, bond index ETFs are often substantially cheaper than buying the underlying bonds; sometimes even a factor of 10 or greater. Furthermore, trading in the over-the-counter bond market takes longer and requires more resources. "If you want to get it done quickly and cheaply, and done in one shot, ETFs are the optimal vehicle," said Goutam.
But it's not an either/or, he added: "It's incredibly common for institutions to use ETFs to provide quick beta exposure to the fixed-income asset class, then to choose specific bonds to give them alpha."
Intriguingly, use of smart-beta bond ETFs grew by 18% year-over-year; these funds are now used by a quarter of institutions that use ETFs. With only 61 smart-beta bond ETFs holding just $16 billion in assets, the segment remains a niche of a niche. Yet interest is apparently growing. The question now is whether investors will be satisfied with the smart-beta bond ETFs available, or whether the paucity of choices will inhibit the segment's further growth.
US Investors Still Don't Buy That ESG Boosts Returns
European institutions long ago boarded the environmental, social and governance (ESG) investing train, and ESG-backed investments are commonplace in portfolios overseas. That isn't quite the case in the U.S., where institutions have proven much more skeptical of ESG's benefits.
Whereas 43% of European institutions "believe" that ESG investing leads to strong returns long term, in the U.S., only 8% do. (That "believe" isn't us editorializing; it's the wording used in the report.)
This perception isn't exactly justified: As we've covered in the past, ESG ETFs have actually seen significant outperformance recently, particularly in 2017 (the time period of the Greenwich survey).
Yet only 15% of U.S. investors have sold out of certain strategies or invested in new ones as a result of ESG considerations, compared with about half of European investors. In fact, more than half (54%) of U.S. institutions surveyed say they didn't see any need to incorporate ESG factors into their investment decisions.
On this, the U.S. is an outlier, says McCollum, and over time, the U.S. will likely catch up to its foreign peers.
"The European institutional market has been focused on ESG for over a decade, while the U.S. market is in the early stages of adoption," explained McCollum. "As U.S. institutions further integrate ESG into their investment portfolios, the markets are likely to look more similar in the future."
Contact Lara Crigger at [email protected]