InvestmentsApr 13 2015

Investors attracted by transparency

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Fixed income exchange-traded funds (ETFs) started life, along with the rest of the ETF market, in the US and Canada, but these products are becoming increasingly familiar to UK and European investors.

The most recent figures from research firm ETFGI.com shows there are 91 fixed income exchange-traded funds or products (ETPs) that have their primary listing in the UK.

Deborah Fuhr, managing partner at ETFGI, says in January and February this year, 32 ETFs were brought to market in Europe as new products. Of these, 20 were equity products, while only seven were fixed income ETFs, pointing to the enduring popularity of equities in an ETF structure.

“People are just more familiar with equity benchmarks and investing in equities,” she notes. “Fixed income is a newer area and very few investors are really familiar with fixed income indices.”

Following the strong performance of fixed income last year, though, many investors will still want to allocate to bonds and gilts in 2015, and ETFs can be an efficient and cost-effective way of doing so.

Data from ETFGI for February 2015 show net inflows for the month of $50.7bn (£33.96bn) for ETFs/ETPs, with equity ETFs/ETPs garnering the largest net inflows at $30.4bn, followed by fixed income ETFs/ETPs with $15.6bn.

At their most basic level, fixed income ETFs offer a “straightforward way to add some fixed income ballast to a portfolio”, says John Adu, head of UK exchange-traded product distribution at Deutsche Asset & Wealth Management.

But there are a range of ways in which investors can use these products, as Mr Adu explains: “We’ve seen other investors trade fixed income ETFs more tactically and there are now enough fixed income ETFs out there to allow positions to be taken with increasing granularity on the bond market. Investors can also use ETFs to target longer-duration fixed income exposure, which is important in a low-yield environment.

“Meanwhile, given that trading spreads on some fixed income ETFs can be tighter than trading the equivalent basket of bonds, some investors will use the ETF for tactical trading of bond portfolios at low cost.”

Deutsche Asset & Wealth Management saw net inflows of €350m (£254.96bn) in January 2015 alone into its range of six fixed income ETFs offering cash exposure.

Meanwhile, providers such as ETF Securities and Lombard Odier Investment Managers have jointly launched fixed income ETPs, and iShares launched an ETF in February offering exposure to the European corporate bond market.

“Investors are increasingly turning to ETFs as a way to gain precise exposure to markets that have otherwise been difficult to access,” says Tom Fekete, head of product development for iShares in Europe, the Middle East and Africa.

Generally speaking, ETFs are “very efficient and transparent products” that are also highly regulated within the Ucits framework, Mr Adu argues.

Howie Li, co-head of Canvas, an ETF-based solution at ETF Securities, agrees one of the benefits of accessing fixed income via an ETF is the transparency of pricing in an asset class “that is otherwise opaque”.

He elaborates: “Take equities – stocks are valued and priced on the stock exchange, so if you want to buy an individual stock on the FTSE 100 it will be priced, yet bonds are not priced like that – they are priced over the counter.

“But within the fixed income ETF you have real-time pricing during stock exchange hours. The ability to put transparency on pricing in an opaque asset class is certainly a benefit for trading fixed income ETFs.” Mr Li predicts more fixed income product launches this year.

Meanwhile, Ms Fuhr believes there is growing awareness among UK and investors globally of the range of ETF products providing exposure to different areas of fixed income, but she warns education is an impediment.

“Fixed income indices have very different methodologies in the way they are constructed. It is harder to get good information on pricing, and all these things are going to lead to a slower adoption rate because it is harder to understand from the investors’ point of view,” she observes.

She acknowledges, however, that since the Retail Distribution Review, advisers have turned their attention to the ETF market. “Now that financial advisers are having to look at the whole of the market, awareness of ETFs is growing,” she says. “That has been a positive thing for investors in the UK.”

Ellie Duncan is deputy features editor at Investment Adviser

EXPERT VIEW

John Adu, head of UK exchange-traded product distribution at Deutsche Asset & Wealth Management, says:

“We will see many more fixed income ETFs appearing on the market in the next few years. The global fixed income market is enormous and ETFs tracking fixed income benchmarks constitute only a small part of the notional market.

“In Europe, the ETF fixed income market is over €110bn, having grown by 50 per cent through the course of 2014. As we are experiencing with equities, we will also likely see the emergence of fundamentally weighted fixed income ETFs, which could be described as strategic, or ‘smart’ beta, types of products. There is currently demand for fixed income indices to represent a company’s ability to repay its debt (as opposed to debt outstanding) while still offering attractive yields.”

KEY FIGURES

$15.6bn

Net inflows into fixed income ETFs/ETPs in February 2015, according to ETFGI

$8bn

Net outflows from equity ETFs/ETPs in January 2015, ETFGI reports, but a recovery in February saw net inflows of $30.4bn

20%-25%

Potential annual asset growth in the European ETF market in 2015, forecast by the ‘EY Global ETF Survey: 2015 and Beyond’