By Terry Flanagan

Institutions Flock to Bond ETFs

Institutional investors are increasing their use of ETFs for fixed income in order to gain exposure to the asset class.

“As decreased fixed income bond liquidity has driven institutional investors to explore new ways to access fixed income markets, fixed income ETFs are increasingly being used by investors to access liquidity and implement investment strategies,” said Matthew Tucker, head of iShares fixed income investment strategy at BlackRock.

Some 55% of institutions invest in domestic fixed income ETFs, according to a survey by Greenwich Associates. Usage of domestic fixed income is most common among insurance companies at 78%, although 74% of registered investment advisors also employ ETFs in domestic fixed income.

Institutional investors that began using exchange-traded funds(ETFs) for manager transitions, rebalancing and other tactical applications are increasingly employing ETFs for strategic purposes, such as gaining long-term exposures to desired asset classes.

Institutional investors are gravitating toward “unconstrained” strategies, i.e., those that aren’t tied to benchmark-specific guidelines, providing them with leeway to take on greater exposure in areas such as high-yield.

“Our message to bond investors is to move toward an unconstrained approach,” said Karl Dasher, head of fixed income at Schroders plc, at a press briefing this week. “Over the past three decades, investors have been afraid of trading out of the rally, but going forward, they will have to pull all the levers to generate a relative return, which will require a less constrained approach.”

As investment grade corporate bond markets struggle with liquidity and transparency of pricing, institutional investors continue to use fixed income ETFs to efficiently manage their bond portfolios.

BlackRock iSharesBonds Corporate ex-Financials Term ETFs, which provide bond-like features in addition to the benefits of an ETF, including exchange-traded liquidity, transparency and diversification.

The iSharesBonds Corporate ex-Financial Term ETFs will provide efficient access to a diversified pool of investment grade corporate credit with a defined maturity date. While relevant to all investors the products are expected to appeal to institutional clients such as bank treasurers.

“Bank treasurers are challenged with building diversified portfolios in an environment of low liquidity, low yields and interest rate volatility,” said Tucker. “iSharesBonds aim to meet the needs of these clients by offering the regular income and end date of a bond as well as the exchange liquidity, transparency and diversification of an ETF.”

The Greenwich report reveals that institutional investors are employing ETFs for both tactical and strategic purposes. Across all institutions participating in the study, 58% describe their use of ETFs as generally strategic or long-term in nature, a slight increase from 57% in 2012. In general, Greenwich Associates defines a strategic investment as any asset that is held for a year or longer.

ETFs have also proven themselves as especially effective tools for tactical portfolio management, for example adding liquidity through an ETF overlay, and ETFs continue to be used widely in this manner. 70% of institutional ETF users employ ETFs for tactical portfolio adjustments, up sharply from 48% in 2012.

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