LIQUIDITY NEEDS FUEL DEMAND FOR ETFs.
The Greenwich Associates report identifies that liquidity needs will fuel demand for ETFs in fixed income. Another trend identified is that ETFs are increasingly being used for core, strategic and tactical applications.
Source’s Mellor highlights a number of drivers behind the increase in use of ETFs by UK institutions including the fact that the investors can invest through ETFs just as easily as buying a share, the low cost of ETFs, transparency over what they are buying, precision of exposure and efficiency of index replication.
There is no surprise that fixed income ETFs have seen very strong growth over the past three-to-five years and now all ETF providers have fixed income as one of their key strategic corporate objectives.
This expansion into fixed income has been driven, as Mellor says, by pension schemes’ increasing need for liquidity in portfolios.
“Primarily the demand for fixed income ETFs is the same as for any other ETF: low cost, efficient tracking, transparent structure and ease of trading on exchange,” he says. “An additional benefit of many fixed income ETFs is that they may be tracking a benchmark that is designed to select bonds that are more liquid, but this is a secondary rather than primary benefit.”
Source’s research also found there are a number of different roles ETFs play in institutional portfolios, including: long-term broad market exposure (70% of respondents), tactical adjustment (64%), liquidity management (51%), long/short investment strategies (42%), sector rotation (40%), cash equitisation (30%) and transition management (19%).
MULTI-ASSET DRIVES FIXED INCOME ADOPTION
Garcia-Zarate explains the adoption of fixed income ETFs was initially driven almost entirely by multi-asset desks and not by the big investors in fixed income, such as pension funds and insurance companies.
“These multi-asset desks saw the equity trading features of ETFs as a very flexible tool to meet fixed income needs in a comprehensive manner and without having to bother with the intricacies of operating OTC with multiple bond lines,” explains Garcia-Zarate.
He adds in the past few years, anecdotally providers say the power-users of fixed income have utilised ETFs – citing liquidity as one of the reasons.
Garcia-Zarate says: “The combination of post-crisis regulation and central bank policies have diminished inventory in fixed income markets. ETFs, with their secondary market liquidity, offer a solution for this particular issue.
“Heavily-traded fixed income ETFs allow fixed income investors to engage in very dynamic buying/selling of fixed income exposures while having limited net effect on the underlying (i.e. primary) market. This has become very handy in a market where available bond inventory has declined.”
