01.19.2012
By Terry Flanagan

Fixed Incomers Look to ETFs for Clarity

Exchange traded funds continue to blossom across all asset classes, but may make life easier especially for fixed income investors.

Passive investment strategies, whether it’s through indexing or exchange traded funds (ETFs) has grown exponentially popular among investors. Yet, constant debate over whether every index, benchmark or security from each asset class can be turned into an exchange traded instrument has left some skeptical.

In Europe, fixed income ETFs total 14.3 billion euros. Fixed income ETFs, an area that has been central to the debate over just how complex ETFs can become. Contrary to some market sentiment, fixed income investors in the region have come to favor ETFs for their ability to enhance price discovery for more esoteric instruments.

“Users of ETFs simply need to monitor the illiquidity of the benchmark they’re tracking and know that the underlying’s illiquidity will be reflected in the ETF,” said Paul Amery, head of IndexUniverse’s Europe, an independent authority on passive investing. “But investors are finding that ETFs can actually help with price discovery of the underlying…especially if there’s a lack of other indicators, like futures contracts.”

Enhancing price discovery remains to be critical for many traders, along with the plight to achieve best execution. While fixed income ETFs may make it easier for investors to see the light when it comes to pricing, trading them can still be tricky. Such a task is particularly difficult with some OTC (over the counter) fixed income trades that leave prices up to the subjectivity of brokers.

“It’s really hard to trade fixed income, and achieving best execution when trading fixed income ETFs is not immune to those difficulties,” said Samu Lang, portfolio manager at Finnish based asset manager, Taaleritehdas Fund Management Company. “You need to know how many market makers there are in this space, who uses what prices and have a really good relationship with your brokers. There’s no NAV (net asset value) available at times and it can ultimately be a very time consuming trade.”

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