Natacha Blackman of iShares looks at the rise of fixed income ETFs
The European bond market is modernising at a rapid pace - and fixed income exchange-traded funds (ETFs) have become the vehicle of choice for this modernisation. This reflects their liquidity, transparency and increasing versatility.
Over the past five years the European corporate bond market has grown by 56% to €2.8trn (£2.4trn) in debt outstanding [Source: Bloomberg Barclays, as at 30 June 2020].
Trading is increasingly done electronically. One driver is the EU's MiFID II directive, which came into force in 2018, moving trading onto regulated venues and imposing new obligations for regulatory trade reporting, trade transparency and best execution. This is all much easier to do via electronic markets.
Fixed income ETFs have grown rapidly too. The $334bn (£243.5bn) European UCITS-listed ETF market has shown a compound annual growth rate of 22% over the past five years [Source: BlackRock, as at 31 January 2021].
The Covid-19 crisis was a big test of European fixed income ETFs' liquidity for institutional investors. During the March 2020 volatility in financial markets, ETFs proved their resilience, trading efficiently and offering liquidity, flexibility and price transparency. They continued to track their benchmarks closely.
UCITS fixed income ETFs traded an average of $5.3bn a day in March, almost twice the 2019 daily average [Source: BlackRock, Bloomberg, as at 30 June 2020]. Moreover, while secondary trading volumes of fixed income ETFs fell during the months that followed, individual ETFs kept setting new records.
As the ETF market grows, so too does its ecosystem. We see this in practice through the growth of lending and options markets.
Recent years have seen an increase in lending of fixed income ETFs. The stock of EMEA-listed fixed income ETFs available for borrowing has increased by more than 60% in the past three years, to reach $14bn in June 2020. Balances on loan have more than quadrupled [Source: IHS Markit, as at 30 June 2020].
Continued adoption of fixed income ETFs and other bond index tools, growth in electronic trading, algorithmic pricing capabilities and dramatic improvements in technology are revolutionising the way investors access European corporate bond markets. The recent Covid-19 selloff proved to be a catalyst for further adoption of fixed income ETFs, particularly by institutional investors.
Investors are increasingly managing their fixed income exposure through a portfolio lens, using a broader toolkit to access European corporate debt. The largest and most liquid ETFs are becoming the macro and scalable risk transfer tools of choice for investors. ETFs also offer a standardised index-based tool that allows for ESG integration. Market transparency is expected to continue to improve and positively feed into the liquidity of the underlying bond markets.
This change is to the benefit of investors. However, given the still opaque nature of the underlying cash bond market, coupled with the lack of a timely, unified picture of bond trades and pricing (a consolidated tape), we believe ETFs play an integral role for investors looking to access euro corporate bond exposure, whether investment grade or high yield.
Looking to the future, another key driver of growth will come from investors' increasing transition to sustainable investing. As this shift gains momentum, we expect sustainable fixed income ETFs to become flagship funds for investors.
Natacha Blackman is a fixed income product strategist at iShares EMEA
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