Bond Markets and Institutional Bond Portfolios Could Increase Use of ETFs
Fixed-income exchange-traded funds (ETFs) are poised to take on a bigger role in institutional portfolios, according to a new report, Institutional Investors Turning to Fixed-Income ETFs in Evolving Bond Market, from Greenwich Associates.
Institutional investors are making sweeping changes to their fixed-income portfolios in response to the post-crisis regulatory changes in the bond markets, current interest-rate environment and expectations of future rate increases. The results of this new research, conducted at the end of 2013 by Greenwich Associates and sponsored by iShares, suggest that these responses could provide a significant boost to ETF use by institutions.
“As institutions move to shorten duration and find new sources of yield, current users of fixed-income ETFs expect to increase their use of the product and some non-users will elect to employ ETFs in implementing their portfolio strategies,” says Greenwich Associates consultant Andrew McCollum.
The research demonstrates clearly that institutional investors experimenting with fixed-income ETFs quickly begin increasing their use of and allocations to these products. About 60% of the institutional ETF users participating in the study allocate more than 10% of fixed-income assets to ETFs, including almost one-third allocating between 10% and 30%.
One-third of institutions now using ETFs say they plan to increase their investments in these products in the next 12 months, including 43% of investment managers and 38% of institutional funds. While most current users expect to increase allocations to ETFs by 1-5%, a quarter plan increases of 6-10% and about one-in-10 expects to boost ETF investment by more than 20%. One-in-five non-users plan to start investing in fixed-income ETFs in the coming year.
ETFs Helping Institutions Adapt
Institutions indicated their top application of fixed-income ETFs is a strategic one—to obtain passive exposures in the core component of core-satellite portfolio constructions. With a strategic application already emerging as the most-cited fixed-income ETF use case among institutions, the evolution from tactical to strategic use appears to be taking place even more rapidly for this asset class, perhaps due to the challenges to investing in fixed-income secondary markets.
Benefits and Provider Preference
The institutions cite ease of use, liquidity, quick access, single-trade diversification and lower trading costs as main benefits to employing ETFs.
When it comes to selecting an ETF provider, pricing represents a key driver. Thirty-eight percent of institutions name “better pricing” as one of the three most important factors considered when selecting an ETF provider. The next closest factors are “liquidity” and “breadth of product offering,” which are named as the top consideration by about 21% each.
“Based on those factors, the fixed-income ETF users participating in Greenwich Associates’ research name iShares/BlackRock as their preferred provider of bond ETFs,” says Andrew McCollum.