ETPs offer new route into fixed income

According to the BlackRock ETP Landscape high­lights report for August 2014, investors globally flocked to fixed income, which saw flows of $11.5bn (£7.1bn) during the month.

The report acknowledges that this figure includes a high-yield rebound, although it points out the majority of new assets went to safer long-duration Treasury and investment grade corporate funds.

Ursula Marchioni, head of ETP research EMEA at iShares, says: “In Europe we’ve seen this too. Europe-listed fixed income exchange traded products (ETPs) have been a big driving force behind flows, with assets recently surpassing $100bn.”

Figures from Morningstar show that in the first half of 2014 the European ETP market saw ¤10bn (£7.8bn) of new money placed in fixed income ETPs. But while fixed income products proved popular among investors in the first quarter, equities were back in favour in the following three months.

Jose Garcia-Zarate, senior ETF analyst at Morningstar, notes: “The flow data reveals that while ETP investors placed more net new money in fixed income than equity in the first quarter of 2014 (¤5.4bn versus ¤2.6bn), the opposite happened in the second quarter (¤4.5bn versus ¤10.5bn).”

So is fixed income exposure via passive investing strategies efficient?

Dan Attwood, proposition manager for retail index funds at Legal & General Investments, believes it is.

“When looking at a fixed income index, one of the key benefits will be the lower fees – and that’s really important in terms of the ongoing costs to the investor,” he says. “It’s quite a low-yield environment, so the impact of fees can be huge, especially as there has been a shift to using shorter-dated funds that have a lower yield – and the impact of actively managed fees on that can be pretty significant.”

He also suggests that investors favour the consistent performance these types of products deliver. “You’re producing benchmark returns and that might fit in with risk-targeted models,” Mr Attwood adds.

He argues, however, that it can be difficult for active fund managers to add value in fixed income asset classes.

“There are few opportunities for fund managers to add value over the longer term. There are definitely advantages to using fixed income index funds,” he continues. “I think index has been almost a default choice for a lot of investors for quite a long time.”

Viktor Nossek, head of research at Boost ETP, notes that in the ETF space, fixed income is relatively underrepresented, accounting for roughly $300-400bn in assets under management in an industry that he says is worth a total of $2.7trn.

He explains: “I think ETFs are looking to gain a stronger foothold within the fixed income space, also because fixed income offers unique opportunities, in terms of diversification.”

Mr Nossek adds: “The equity market is very well covered both in terms of geography as well as sectors or thematic. But within fixed income what really dominates are the products around government bonds. Japan, the US, Germany and Italy are the largest issuers in the world, so most government bond indices have exposure to these four countries only.

“The bond market needs more development in terms of getting traction among investors seeking both liquidity and diversification.”

Ellie Duncan is deputy features editor at Investment Adviser

Expert view: fixed income

Ben Seager-Scott, senior research analyst at Bestinvest, says while there is an argument for using passives due to their lower costs in areas such as managed pensions, where the various extra layers add to the total cost, it’s not one he thinks holds much water.

“Underlying investments should be considered based on their after-fees return. Otherwise you risk cutting off your nose to spite your face. That said, in terms of steer, I think that passives (particularly ETPs) are most suited to large, blue-chip equity indices where liquidity and effective secondary markets systems operate.”