Large institutions enter the bond ETF space

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Large institutions are increasingly using bond exchange-traded funds to manage their portfolios according to market participants, who expect this trend to increase liquidity and reduce trading costs in fixed-income ETFs for all investors. investors.

Adam Gould, head of equities at Tradeweb, an electronic trading platform, said fixed income securities accounted for half of all trades with a notional value of more than $5 million on his ETF platform. US institutional in the first quarter of this year, down from 36 percent. cent during the same period last year.

High value exchanges can be an indication of the activity of large institutions.

Additionally, Tradeweb said the number of clients trading fixed income ETFs on its institutional platform increased by more than 20% in the first quarter of this year compared to the same period a year ago.

Industry watchers are looking for indicators of increased institutional interest in bond ETFs since the US Federal Reserve decided to step in and buy them as part of a massive package to support the economy. at the height of the Covid market sell-off in 2020 This action, widely interpreted as a stamp of approval for fixed income ETFs, has been cited as one of the reasons for renewed interest in the funds this year- the.

To be sure, regulators agree that ETFs, and bond ETFs in particular, passed their biggest stress test with flying colors, despite huge dislocations at the time between bond ETF prices and the value of the underlying bonds. .

A sign that larger institutions have started to embrace bond ETFs would be faster growth in assets under management in bond ETFs than in the rest of the ETF market. However, data from ETFGI, an advisory firm, suggests there has been little change in the proportion of assets held in fixed income exchange-traded products compared to their counterparts in equities and commodities. .

Fixed income securities accounted for 18.3% of the ETF market in December 2020, a figure which fell slightly to 15.9% in December 2021 and remained virtually unchanged at the end of April 2022 at 16.2%.

“I think the Fed using ETFs has demonstrated that they’re a valid investment vehicle,” ETFGI founder Deborah Fuhr said, but added that she didn’t see a disproportionate shift toward fixed income securities. “I think people are embracing fixed income ETFs more, but they’re embracing all ETFs more.”

Nonetheless, Gould insisted that the liquidity of fixed income ETFs in March 2020 relative to their underlying constituents did not go unnoticed by large institutions that had not traded them until then.

“Not having access to one of the most liquid tools makes no sense. If you’re an institutional investor, you want to be able to access what you can,” he said.

Since then, Gould said he’s seen more large clients move in to trade fixed income ETFs by building relationships with market makers and liquidity providers.

Carolyn Weinberg, global head of product for iShares and index investing at BlackRock, also said she’s seen an increase in institutional use of bond ETFs.

A report by BlackRock last week noted that $40 billion flowed into global bond ETFs in the first quarter of 2022 “even as a generational rise in inflation and tighter monetary policy led to a sharp decline prices for closely watched bond benchmarks”.

BlackRock expects bond ETF assets to grow from $1.7 billion today to $5 billion by the end of this decade and one of the drivers of growth will be their use by institutional clients like liquidity management and portfolio efficiency tools. She notes, for example, that eight of the 10 largest U.S. insurers use bond ETFs, but five of them only adopted them after the March 2020 volatility.

The increased interest in bond ETFs by institutions is good for the overall market, Weinberg argued. “Bond ETFs actually minimize the impact on the market,” she said, saying that not only do ETFs typically trade at tighter spreads than bonds themselves, but that “we’ve also seen the bid-ask spreads of the underlying bonds will tighten due to the increase in bond trading”. AND F “.

State Street is one player hoping to take advantage of the reported uptick in institutional interest in bond ETFs. It launched the State Street MarketAxess Investment Grade 400 Corporate Bond ETF (LQIG) earlier this month.

In a white paper accompanying the ETF’s launch, State Street and MarketAxess noted an increase in fixed income e-commerce and said ETFs were an integral part of that change. “ETFs, and therefore the indices on which they are based, act as an accelerator of evolution,” they said.

Whether the use of bond ETFs will eventually increase as a proportion of all ETF trading remains uncertain, but there is growing evidence that how they are traded and how they are used are changing. rapidly.

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