As demand for fixed-income exposure persists, investors must consider different categories and product types
With uncertainty about the direction of stocks on top of investors’ minds, portfolio exposures are shifting toward alternatives or safety. Some may find what they’re looking for in gold or other haven assets; others might be tempted by more exotic strategies in the private markets.
But for those focused on the investment-fund space, fixed-income ETFs have proven to be a top choice. “A net US$75.2 billion flowed into bond funds listed on U.S. exchanges in the first half of the year, compared with US$56.5 billion for U.S.-listed equity ETFs,” reported The Wall Street Journal, citing figures from ETF.com.
The Canadian picture is particularly bright. A report issued by the Canadian ETF Association (CETFA) in May noted that fixed-income mandates accounted for a 58.5% share of total ETF net creations in the first quarter of 2019, in contrast to the 27.2% they managed over the entirety of 2018. National Bank of Canada has also reported fixed income to be the fastest-growing segment of the Canadian ETF industry, posting 37% growth over the last 10 years.
But while the reason to purchase bond ETFs is straightforward, the same can’t be said for the broad market. “[W]hile bond funds can help offset the risk of stocks, many carry substantial risks of their own,” noted The Wall Street Journal.
Two commonly observed features are debt maturity and issuer. Conservative investors are inclined to hold shorter-term government debt, which is less exposed to sharp interest-rate movements as well as credit risk. Others who are more daring may diversify to include higher yields and more credit risk, with debt securities from companies as well as government.
“Assets in what FactSet ETF director of research Elisabeth Kashner calls ‘plain vanilla’ funds that track broad bond indexes have jumped 21% since the end of 2017 through returns and investment inflows,” the Journal reported. But investors in bond index ETFs ought to realize that due to the relative illiquidity of bonds compared to stocks, such funds don’t hold every security in the benchmark they track; an index might include 3,000 bonds, but the ETF might hold just 1,000.
Research also reveals growth differences among specific segments. In the US, active bond ETF products of all maturities and disciplines have swelled by 82% to US$61.2 billion in terms of assets since 2017; defined-maturity products, meanwhile, have nearly doubled to US$18.6 billion in the US. CETFA’s report in May showed $2.5 billion in net inflows for investment-grade bond ETFs during Q1 2019, whereas high-yield ETFs experienced $60 million in net redemptions.
To stake their claims in the expanding space, portfolio managers are trying to strike a balance between focusing on their preferred markets and offering some differentiation. One strategy highlighted by the Journal targets high-yield debt that once held an investment-grade rating, following the theory that such fallen angels are less risky than debt that’s never been in good standing with ratings firms.
