Exchange-traded funds are among the beneficiaries as fixed income recovers from the slump of 2022
by Brian Gorman
Money is pouring into fixed income exchange-traded-funds (ETFs) at a record rate as investors’ worries about inflation start to ease.
In January 2023, net inflows into fixed income ETFs reached US$9.4bn, “surpassing the buying seen in April 2020 following the aggressive central bank response to the pandemic,” according to Invesco’s monthly ETF fixed income update covering Europe, the Middle East and Africa.
Investor trends
Invesco notes two key themes. First, it says that investors are returning to euro-denominated bonds after last year favouring US dollar-denominated bonds. The previous year’s caution on euro-denominated bonds was “to avoid the Russia-Ukraine conflict and the impact of higher energy prices on the eurozone economy”, according to an article on ETF Stream by Paul Eckett.
The second theme Invesco notes is that investors are “increasing risk within their fixed income portfolios”, with strong flows into emerging market debt and high yield products, which appears to be driven by improving market sentiment with the majority of rate hikes having already taken place and inflation starting to cool.
A similar pattern can be seen in the United States, according to an article on the website of investment research provider Morningstar by Ryan Jackson. In January 2023, inflows of US$24.4bn into bond ETFs “represented stronger organic and absolute growth” than stock ETFs which collected US$20.9bn, writes Jackson. He points to strong flows for bond funds at the higher end of the risk spectrum. This includes corporate bond ETFs attracting US$4.5bn in January, the biggest monthly inflow since the summer of 2020.
However, Jackson notes a continuation of the exodus from inflation-protected bond funds, which “leaked” US$1.6bn in January, “their fifth consecutive month of outflows”. This trend may be reversed soon, he writes, “but recent struggles have left them with a black eye”.
In the UK, inflation-linked bond ETFs were among the worst performers in 2022. For example, the Bloomberg UK Government Inflation-Linked Bond Index returned -34.5%. Products tracking this index include BlackRock's iShares £ Index-Linked Gilts UCITS ETF.
Inverted yield curveA story on CNBC by Kevin Schmidt also highlights a resurgence for bond ETFs, giving an inverted yield curve – when short-term bonds have a higher yield than long-term bonds – as one reason.
Schmidt’s story cites a CNBC show that quotes a head of research from financial analysis firm VettaFi, Todd Rosenbluth: “There’s now income within the fixed income ETFs that are available. … We’ve seen higher-quality investment-grade corporate bond ETFs. We’ve seen high-yield fixed income ETFs see inflows this year, as well as some of the safer products.”
Schmidt said that with yields at their highest in decades and equity valuations soaring, investors are “hunting for pockets of strength as they await whether a soft landing is in the cards this year”.
Bond ETFs are growing rapidly from a low base. In 2022, BlackRock, a major ETF provider, forecast that assets under management in fixed income ETFs would triple to US$5tn by 2030.
“Over the past two years more wealth managers have put bond ETFs at the centre of their portfolios and institutional adoption of bond ETFs has broadened and deepened,” the company said.
EU mulls kickback ban
Regulatory moves could also help the case for ETFs.
“The European Commission is weighing up banning kickbacks [also known as retrocessions] that financial advisers receive when they sell investment products, a move that would drive greater uptake of low-cost products such as ETFs,” according to an article in ETF Strategy by James Lord.
Lord points to a speech on 24 January by Mairead McGuinness, European commissioner for financial stability, financial services, and the Capital Markets Union, who notes that retail investment products containing inducements were, on average, more than a third (35%) more expensive compared to similar products without the kickback commission.
McGuinness said: “We need to ask ourselves whether commission-based models really work in the interests of retail investors. I want consumers to have access to financial advice, but biased advice does not serve them either.”
Retrocessions are already banned in the UK and the Netherlands.