Do you have Netflix? I do—and I love it for all the obvious reasons (cheap, easy access to great shows). But there’s one area where Netflix misses the mark for me: when it tries to make recommendations based on what I’ve watched in the past. Right now, for example, because I’ve finished watching Orange Is the New Black, it’s now suggesting I replace it with Prison Break and Breakout Kings. And while I’m sure those are perfectly good shows—and they are about prison life—they’re just not going to give me the same kind of fix, you know?
The latest Netflix substitution suggestion popped into my head when I read this article on how institutional investors are using bond exchange-traded funds (ETFs) to fill in for traditional over-the-counter bonds—bonds that are becoming harder and harder to find through traditional sources. Wall Street firms have largely pulled back from the bond market and are holding fewer corporate bonds than they did prior to 2008, according to Reuters.
ETFs are there to fill the growing gaps in institutional portfolios, which is good news.
But investors also need to understand that they don’t behave exactly like the real deal. When it comes to bond ETFs, there is a significant difference: ETFs trade throughout the day like stocks—bonds, on the other hand, are pretty illiquid beasts. Some don’t trade for days or weeks. That’s a mismatch investors need to understand and be aware of when they’re using ETFs as a substitute. Sure, bond ETFs can plug the holes in a fixed income portfolio—but they’re also susceptible to the kinds of market mood swings that aren’t really characteristic of the underlying bonds.
Bond ETFs are likely to continue their strong run—institutions need bonds and the supply has shrunk markedly since the crisis. As Reuters points out, primary corporate bond dealers are only holding $57 billion in individual bonds compared with $250 billion before 2008. But more and more investors need to look closely at what’s under the hood of a particular ETF to ensure that it has the right characteristics to make it a good fit.
Otherwise the experience could be less than entertaining.
A few other key statistics about institutional bond ETF use from the Reuters article:
- bond ETFs have seen $22 billion in deposits this year from investors;
- total assets for ETF bond funds have hit $410 billion;
- junk bond ETFs have risen $4.3 billion this year up to $55.3 billion;
- the $4.2-billion SPDR Barclays Short-term High Yield Bond ETF received $2.7 billion in net deposits from investors over the past year; mutual funds owned 7% of the ETF’s shares at the end of 2013;
- institutional investors and registered investment advisors accounted for 9% of the net new business in BlackRock’s $14-billion iShares iBoxx $ High Yield Corporate Bond ETF so far this year, the company said; and
- almost one-third of large dealer banks reported that bond ETF use was on the rise among institutions, according to a Federal Reserve survey released in January.