Bond ETF Flows Shift To Safety

Fixed-income ETFs saw healthy inflows of $15.3 billion for the quarter in spite of a tough environment.

The most followed benchmark, the Bloomberg Barclays U.S. Aggregate Bond Index, had a loss of -1.48% for the quarter. The loss can be attributed to credit spreads widening and the rise in interest rates, coupled with market uncertainty about tariffs and tech regulations.

Yet a closer look at the flows of bond ETFs helps us identify key trends that developed during the quarter and understand how advisors used different ETF strategies to navigate this challenging time.

Active Management Popularity

While actively managed funds have struggled to find traction in other areas of the ETF market, active strategies are popular in fixed-income ETFs.

Their popularity may be due to liquidity and replication constraints in the bond market, which makes it difficult for ETFs to track a passive benchmark. Still, investors also look for managers who can provide alpha in uncertain times.

During the first quarter of the year, actively managed bond ETFs gathered a total of $3.1 billion according to FactSet data; with the iShares Short Maturity Bond ETF (NEAR) being the biggest gainer, with inflows of $619 million, with the fund’s assets under management now more than $35 billion.

Still, inflows were distributed among all fixed-income groups.

Q1 2018 Flows By Focus & Active Per SEC

Data provided by FactSet

Notably, this trend can be seen in high-yield ETFs, where actively managed funds saw inflows of $450 million versus outflows of $5.4 billion on their passive peers.

It appears investors and advisors trust managers to find opportunities where high-yield securities can compensate returns even with widening credit spreads and rising interest rates.

For the first quarter, they were rewarded as active high-yield ETFs on average outperformed their passive peers with a 1.21% total gain against a loss of 0.21% for the latter.

Duration Strategies At Play

Flows for the quarter also reveal how investors have allocated funds to counter rising interest rates.

Duration-hedged ETFs received $509 million in the first quarter. These ETFs add a short Treasury overlay to mitigate interest rate risk. The ProShares Investment Grade-Interest Rate Hedged ETF (IGHG) was the largest gainer, with $190 million inflows. Also, target-duration ETFs—funds designed to maintain a specific duration—saw inflows of $146.72 million.

Furthermore, in a rising rate environment, bond prices fall, and generally, short-duration bonds tend to experience a smaller price drop than bonds with longer duration. At the same time, the Fed raised its benchmark rate by 0.25% in March, thus making it more attractive to invest money in short-term securities.

In fact, fixed-income ETFs exposed to ultra-short term and short-term maturities gained for the quarter $4.6 billion and $4.7 billion in assets, respectively, while ETFs dedicated to long-term maturities lost $476 million in the same period, as seen in the chart below. The biggest gainer in this group was the iShares Short Treasury Bond ETF (SHV), with inflows of $3.3 billion in the quarter.

Q1 Flows Fixed-Income ETFs By Niche

Data provided by FactSet

Treasuries Favored Over Corporates

Another noticeable trend during the quarter was the investor preference of Treasury securities ETFs over corporate ETFs.

Widening credit spreads and stock market volatility favored investor sentiment into safer securities. The TED spread—an indicator of credit risk—closed the quarter at -1.76, as spreads widened 0.37% for the quarter. In addition, the U.S. stock market saw a great deal of volatility.

These developments influenced quarterly flows into Treasury ETFs, which saw inflows of $6.5 billion while investment grade U.S. bonds ETFs had outflows of $3.9 billion and high yield ETFs experienced larger outflows of $5.02 billion.

The top Treasury ETF flow gainers were the iShares Short Treasury Bond ETF (SHV) and the SPDR Bloomberg Barclays 1-3 Month T-Bill ETF (BIL); in contrast with the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD), with total outflows of $5.7 billion, and the SPDR Bloomberg Barclays High Yield Bond ETF (JNK), with redemptions of $3.4 billion.

Flows into fixed-income ETFs may continue to be positive in the coming quarters, as ETFs provide advisors with choices to quickly implement strategies that adapt to any market type, even in challenging markets as the one experienced in the past quarter.

Contact Luis Guerra at [email protected]