Fixed income is one of the hottest corners of the exchange-traded funds industry this year, a trend some market observers believe will continue, particularly as professional investors look for more liquid alternatives to individual bonds.
“While bonds do not trade on an exchange, bond ETFs do and receive the benefits of transparency and intra-day access. When sellers of bond ETF shares exceed buyers, the price of the ETF declines, just as it would for equity securities. If the price of the ETF shares deviates from the net asset value of the ETF's holdings, traders, including authorized participants, can take advantage of the valuation deviation by acting against this market trend. They would purchase an ETF when it trades at a discount and short the ETF if it trades at a premium,” said S&P Capital IQ in a note out earlier this week.
Year-to-date, only ETF has added more new money than the nearly $9.8 billion added by the iShares Barclays Aggregate Bond Fund AGG, the largest fixed income ETF in the U.S. Only three ETFs, including AGG, have seen larger 2016 inflows than the almost $7.2 billion that has flowed into the iShares iBoxx $ Invest Grade Corp Bd Fd LQD, the largest corporate bond ETF.
Through the first half of 2016, about $40 billion flowed into bond ETFs, with approximately half of that total flowing into iShares products. In the third annual version of “Institutional Investors Embrace Bond ETFs,” according to recent study by BlackRock and Greenwich Associates.
Likely due to increased regulatory burdens, 71 percent of the institutional investors surveyed in the BlackRock/Greenwich study said trading bonds is tougher today than it was three years ago. About three-quarters of respondents are altering their investment process as a result.
Indeed, liquidity, including the ability to transact at tight spreads, is a primary concern for professional investors using bond ETFs. S&P Capital IQ notes there are 45 bond ETFs in its coverage universe with bid/ask spreads of two cents or less.
The research firm has an overweight rating on LQD. Earlier this week, iShares cut fees on 15 of its core ETFs, including AGG. AGG saw its fee pared to 0.05 percent from 0.08 percent, making it one of the least expensive bond ETFs on the market today.
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