Puzzle Piece

Last month I had the opportunity to speak on a panel at the ETF.com Inside ETFs Conference. The focus of the panel was the growing usage of ETFs by institutional investors. We talked about why institutions were increasingly turning to ETFs, and discussed some of the investment strategies that they are employing.

On the heels of this panel comes a recent Greenwich Associates report that focuses specifically on the institutional usage of fixed income ETFs. Greenwich surveyed over a hundred fixed income institutions to find out if they used fixed income ETFs, and if so how and why. Some of the report’s findings include:

  • Current users of fixed income ETFs include pension funds, insurance companies, bond fund managers, and registered investment advisors.
  • 59% of current fixed income ETF users in the survey have more than 10% of their bond portfolio allocated to fixed income ETFs.
  • 1/3 of surveyed current fixed income ETF users plan to increase their fixed income ETF allocations in the next year.

The report confirmed what I have been hearing in my conversations with clients: fixed income ETF usage is on the rise. What I found most interesting about the Greenwich study was why institutions are increasingly using fixed income ETFs. The report cites the top reasons as ease of use, liquidity and quick access.

Many investors may be puzzled by this. After all, if I am a professional bond trader or bond manager, surely I have perfect transparency into liquidity and availability. Surely I can trade in the bond market very efficiently. Surely I don’t need a better way to access fixed income.  As it turns out, maybe not. Yes, institutional investors have much greater access to liquidity and inventory than individuals. But the bond market remains much more opaque than the stock market, for everyone. Even the bond market professionals don’t have perfect clarity into what is available and at what price. Even they don’t find the bond market “easy” to use.

That’s what makes fixed income ETFs such a potentially attractive vehicle for both institutional and retail bond market investors. By taking the traditional over-the-counter bond market, and putting it onto the stock exchange, you are much more likely to get better price transparency and liquidity.

Now, some investors may be asking themselves if having a growing number of institutional investors in the market is a good thing.  After all, does that really help the average investor?  Are they better off?  Here it turns out that the answer is probably yes.  Having a larger, more diverse set of investors in the market will generally:

  • Increase trading volumes and available liquidity for everyone.
  • Increased fund size, which generally results in improved tracking error for an index fund versus its index. This helps every investor of a fund.
  • Result in the fixed income ETF landscape expanding, giving investors a larger number of investment choices.

At the end of the day, a larger and more liquid fixed income ETF market can help all investors achieve the same goal: to create a more efficient fixed income portfolio. And that is something everyone can agree is a good outcome.

 

Matt Tucker, CFA, is the iShares Head of Fixed Income Strategy and a regular contributor to The Blog. You can find more of his posts here

Join the Conversation