When we talk of a passive investing revolution in Europe, we really mean equities.
Equities still make up 71% of the European ETF market according to Lipper data show.
So why have bond ETF funds yet to make a major impact?
‘My perspective is that passive fixed income is a decade behind equities, in terms of adoption and sophistication,’ said Michael John Lytle, an ETF consultant and former chief development officer at Source.
‘Traditional fixed income investors do not yet seem to be moving their core exposure into passive solutions,’ he said.
‘I think this is partially because of questions surrounding liquidity and pricing of the bond markets but equally because of fundamental questions surround the construction and objective of existing benchmarks.’
Change in the air
There are some signs of progress. iShares recently launched its 84th fixed income ETF, the Global Aggregate Bond UCITS ETF, a physically replicated fund tracking an index of investment grade bonds across regions and currencies.
The fund offers currency-hedged share classes in sterling, euro and dollars, something which advisers have long been clamouring for.
‘As the broader fixed income market continues to evolve, investors are increasingly seeking the diversification and flexibility that ETFs can offer, and using them alongside traditional security selection,’ said Brett Olson, head of iShares Fixed Income EMEA.
Allan Lane, managing partner at Twenty20 Investments, agreed that fixed income ETFs have ‘a lot of catching up’ to do.
‘But catch up it will, as there's more to grapple with when considering which bonds issues to put into an index,’ he said. ‘In five years’ time I wouldn't be surprised to see the fixed income industry come up with a whole slew of super smart beta ETFs.’
He added that the concept of putting a bond in a wrapper that could be traded intraday was once unthinkable. ‘Fixed income ETFs are in many ways an excellent example of the FinTech revolution, taking the bond trading industry to a new level.’
More assets are flowing towards fixed income ETFs. As of November, $142 billion assets from global ETF investors has been allocated to bond ETFs, according to BlackRock data.
But Lytle argued that many of the most popular bond funds were five or even 10 years’ old. ‘There were 387 fixed income ETFs in Europe the last time that I counted, and the top 20 had 50% of the assets,’ he said. ’This tells me that there are a lot of products but they have not proved relevant, so investors keep putting most of their money into the same funds.’
To gain significant assets, the new iShares’ fund will have to see off competing global bond funds from Amundi, db X-trackers, First Trust and BMO Global Asset Management – a small number of rivals compared to the equity space, where most providers offer a fund tracking the MSCI World Index. AGGG is also the cheapest at 0.10% fees – half the price of its nearest competitor.
Fixed income prices have, surprisingly, risen since 2012, despite new low-cost fixed income ETFs from providers such as Amundi as low as 0.07%. Data from Lipper found that the average total expense ratio of fixed income ETFs in 2017 is 0.22%, compared to 0.38% for equities. Yet five years ago, the average fixed income fee was cheaper at 0.18%, while equities fees have fallen in that time from 0.42%.
But demand remains.
‘Now that the days of zero interest rates are in the past, I suspect a number of players in the ETF industry have already misjudged the looming appetite for bond ETFs,’ said Lane.
‘The constant doubts that some commentators have raised around the topic of liquidity has not been enough to quell the demand from those institutional players who like ETFs’ flexibility and ease of use.’