Are we at a tipping point in fixed-income indexing?

Global survey of institutional investors reveals increased intentions to adopt index products in fixed-income portfolios

Are we at a tipping point in fixed-income indexing?

Many have argued that the fixed-income space represents the last bastion for active managers as index strategies have dominated equity markets. But according to a new report from State Street Global Advisors, that could be changing.

Drawing from a global online survey of 358 institutional investors conducted in May – including pension funds, wealth managers, asset managers, and sovereign wealth funds – State Street found that three quarters of respondents (76%) turn to index strategies for less than 30% of their fixed income portfolio.

But a confluence of factors is prompting substantial change among respondents. Most institutional investors still see value in active fixed-income portfolio management, but partly due to the greater market efficiency enabled by price transparency, the disparity in outcomes between active and index approaches has narrowed in many areas of FI.

When asked whether the active FI strategies they adopted have delivered the after-fee investment performance they were hoping for over the past three years, less than half of respondents said they were “somewhat satisfied” or “extremely satisfied.”

Over the next three years, two thirds (66%) of global respondents said they’re focusing on increasing the use of indexing for broad or liquid, core FI exposures, and nearly as many (63%) said they’re focusing on increasing the use of indexing for less liquid, non-core/satellite FI exposures.

Index-based FI investing also holds substantial appeal among institutional investors looking to support specific objectives with sector exposures. Among survey participants, the top focus areas for planned future allocations include high yield (cited by 44% of participants), developed market sovereign (37%), emerging market debt (36%), global aggregate/core (35%), and investment-grade corporates (35%).

A majority of institutional investors (71%) are also looking to increase the use of ETFs within their global aggregate/core FI portfolios in the next three years, while 48% have a strong appetite to use ETFs more for their non-core/satellite exposures. Beyond that, more than two-thirds (68%) said they are prioritizing increased use of ETFs for FI portfolio construction.

Among the factors driving these plans are ease of use (47%), speed of execution (36%), lower total ownership cost (35%), benefits for transparency/price discovery (32%), and flexibility to hedge currency risks (30%).

The survey also revealed ESG as a mainstream consideration for institutional FI investing, as it is seen to provide a quality lens that FI strategies can be viewed through. Around three out of five (61%) of respondents said they’re prioritizing the integration of ESG within their FI portfolio in the next three years.

Institutions are looking at a variety of approaches to incorporate ESG into their fixed income investing, with the most frequently employed being the “best-in-class” approach (identified by 49%) and the “impact” approach (cited by 39%).

 

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