High-value bond ETF trades rise sharply from last year

Large institutions are increasingly using bond exchange traded funds to manage their portfolios according to market participants, who expect this trend to increase liquidity and reduce fixed income ETF trading costs for all investors.

Adam Gould, head of equities at Tradeweb, an electronic trading platform, said fixed income accounted for half of all transactions with a notional value of more than $5mn on its institutional US ETF platform in the first quarter of this year, up from 36 per cent in the same period last year.

High-value trades can be an indication of activity by larger institutions.

In addition, Tradeweb said the number of clients conducting fixed income ETF trades on its institutional platform had risen by more than 20 per cent in the first quarter of this year from the same period a year ago.

Industry observers have been looking for indicators of a rise in institutional interest in bond ETFs since the US Federal Reserve decided to step in and buy them as part of a massive package to support the economy at the height of the Covid market sell-off in 2020. That action, widely interpreted as a seal of approval for fixed income ETFs, was cited as one of the reasons for a surge of interest in the funds that year.

Certainly, regulators agree that ETFs, and particularly bond ETFs, passed their biggest stress test with flying colours, despite huge dislocations at the time between the prices of bond ETFs and the value of the bonds underlying them.

One sign that large institutions have begun to embrace fixed income ETFs would be faster growth in assets under management in bond ETFs than in the rest of the ETF market. However, data from ETFGI, a consultancy, suggest there has been little change in the proportion of assets held in fixed income exchange traded products compared with their equity and commodity counterparts.

Fixed income accounted for 18.3 per cent of the ETF market in December 2020, a figure that fell slightly to 15.9 per cent in December 2021 and was almost unchanged at the end of April 2022 at 16.2 per cent.

“I think the Fed using ETFs demonstrated that they are a valid investment vehicle,” said Deborah Fuhr, founder of ETFGI, but she added she had not seen disproportionate shift to fixed income. “I do think that people are embracing fixed income ETFs more, but they are embracing all ETFs more.”

Nonetheless, Gould insisted that the liquidity of fixed income ETFs in March 2020 compared with their underlying constituents did not go unnoticed by the large institutions that had hitherto not traded them.

“Not having the ability to access one of the most liquid tools out there doesn’t make sense. If you’re an institutional investor you want to be able to access what you can,” he said.

Since that time, Gould said he had seen more large clients setting up to trade fixed income ETFs by making relationships with market makers and liquidity providers.

Carolyn Weinberg, global head of product for iShares and index investments at BlackRock, also said she had seen an increase in institutional usage of bond ETFs.

A report published by BlackRock last week noted that $40bn moved into global bond ETFs in the first quarter of 2022 “even as a generational rise in inflation and tighter monetary policy resulted in sharp price declines for closely followed bond benchmarks”.

BlackRock forecasts that assets in fixed income ETFs will mushroom from $1.7tn today to $5tn by the end of this decade and that one driver for the growth will be their use by institutional clients as tools for the like of liquidity management and portfolio efficiency. It notes, for example, that eight out of the 10 largest US insurers use bond ETFs, but that five of them only adopted them after the volatility of March 2020.

The heightened interest in bond ETFs by institutions is beneficial for the wider market, Weinberg contended. “Bond ETFs actually minimise market impact,” she said, arguing that not only do ETF typically trade at tighter spreads than bonds themselves, but that “we have also seen bid-offer spreads of underlying bonds tighten as a result of increased trading of bond ETFs”.

State Street Global Advisors is one player hoping to take advantage of the reported rise in institutional interest in bond ETFs. It launched the SPDR MarketAxess Investment Grade 400 Corporate Bond ETF (LQIG) earlier this month.

In a white paper accompanying the launch of the ETF, State Street Global Advisors and MarketAxess noted a rise in electronic trading in fixed income and said ETFs were integral to this change. “ETFs, and therefore the indices on which they are based, are acting as an evolutionary accelerant,” they said.

Whether the use of bond ETFs will eventually rise as a proportion of overall ETF trading remains uncertain, but there is increasing evidence that both the way they are being traded and how they are being used are changing rapidly.