Last week, fixed income exchange-traded funds were once again thrust into the spotlight, this time through a heated discussion between activist investor Carl Icahn and BlackRock CEO Laurence Fink. (See this CNBC article for a rundown of who said what.
Speaking at a hedge fund conference in New York, Icahn said some bond ETFs could magnify the effects of a downturn if investors turn and run at the same time. The showdown between Icahn and Fink follows the previous week’s comments by Bill Gross which were followed by BlackRock’s assertion that bond ETFs in fact foster market liquidity in the bond space.
To be honest, I wasn’t all that clear on precisely what Icahn’s concerns were—but suffice it to say, the exchange he had with Fink continues a conversation that’s been going on for months about investors’ thirst for liquidity and their growing use of bond ETFs especially as the anticipated Fed rate hike draws closer. And I think this broader discussion can be particularly helpful given that some of world’s biggest investors have become significant holders of bond ETFs—clearly it’s worth noting how and why they are using them and what they expect their ETFs to do at the end of the day. Note that, according to ETFGI, at the end of 2014 institutional investors including insurance companies and pension funds accounted for 56% of the US$2 trillion invested in ETFs listed in the U.S. and 42% of the US$2.6 trillion in ETFs listed globally.
So what do institutions want? They’re looking for a fixed income workaround as the Fed gets closer to ending what has been an unprecedented era of stimulus. To pull it off, institutional investors are moving where the liquidity is—and they’re more than willing to pay the price according to this piece from Bloomberg last week.
U.S.-listed high-yield bond ETFs have become an important for many institutions and large investors and the trade sizes. Bloomberg’s Lisa Abramowicz cites a Deutsche Bank report that shows transactions of more than US$1 million make up a quarter of volumes in the two biggest high-yield ETFs, up from 15% in early 2012.
Liquidity is trading at a premium even though some of the more active bonds have underperformed the broader market by 0.8 percentage points this year. Another trend fueling growth in ETFs among institutional investors post-crisis when credit default swaps are no longer a go to proxy for the market.
As I wrote last week, ETFs are a growing part of the institutional investor toolkit. They’re flexible and inexpensive—but like all financial tools, investors should take a careful look at how they’re built and how they deliver what they promise. Part of that is understanding how they maintain liquidity—for fixed income investors, and institutions especially, this is paramount.
Also read: