Why fixed-income ETFs will continue to thrive

Advisors must follow strict due diligence checklist to get best solution, according to State Street Global Advisors

Why fixed-income ETFs will continue to thrive

Flows into fixed-income ETFs are expected to increase this year again and investment advisors should follow a strict due diligence checklist to ensure they select the most appropriate solution for clients.

That’s the message from Bobby Eng, Head of SPDR ETFs Canada at State Street Global Advisors, who told WP the exponential growth of ETFs in Canada is set to continue after last year’s record inflow of $28 billion. 

The U.S. market saw $333 billion of inflows, up 6-7% from 2018, with about half – both north and south of the border – heading into fixed-income assets.

Eng said this is a trend that came through loud and clear in client meetings and that it “makes perfect sense” for both institutional and retail investors given the low cost, liquidity and ease of exposure of fixed-income ETFs.

For advisors, he stressed that selecting the most appropriate product comes down to their due diligence process and suggests four key steps: identifying your exposure; making sure the index construction fits your goals; monitoring tracking error; and then analyzing the daily premiums and discounts relative to NAV.

This checklist will enable advisors to separate the wheat from the chaff and Eng added that the track record of the provider should also be considered.

He said: “Are they well-known? Do they have a strong reputation? Do they have experience in managing ETFs?  Are they going to be around for years to come?”

“With the exponential growth of ETF providers coming into the marketplace, some of these firms you've never heard of before.”

At the end of 2019, Canada held approximately $205 billion of ETF assets in almost 900 different funds, which is high relative to other regions around the world and represents an eight-fold increase over the past decade. There are 35 providers, which Eng believes will likely increase to 40 by the end of 2020.

State Street Global Advisors can lay claim to being a true ETF pioneer, having launched the first U.S. listed ETF, SPY, in 1993, which today is the world’s largest exchange-traded fund. The firm is the third-largest asset manager and the third largest ETF provider with more than $700 billion of assets.

As well as a large uptick in fixed-income inflows, Eng said institutional investors are incorporating them into more strategies as they become more familiar and comfortable with the industry’s robustness.

Building out a liquidity sleeve, added Eng, is something he sees asset managers do heavily. This might mean allocating 2-5% of their active or passively managed funds into an ETF in order to maintain access to liquidity in the portfolio.

Eng said: “It's a small percentage of the portfolio but the assets in total dollars it ends up being substantial.”

Transition management is another strategy where ETFs have become more popular. When institutions move from one active manager to another, an ETF allows them to fill that time gap and avoid being out of the market.  This can be a few days up to a few months.

Also, exposure management via ETFs has grown among institutional investors. Eng explained: “With the variety of different ETFs available, between broad markets, sectors, industries, styles, countries, areas in fixed income, you can use exchange-traded funds to play any type of call you may have.”

The number of strategies is increasing but this is married with the perennial selling point for ETFs – cost. However, Eng told WP the industry is moving away from the scenario of lowest-cost provider wins the asset to the idea of a “total cost of ownership”.

“It’s not just management expense ratio, but your total costs of owning the product, including spread and secondary market liquidity. That tends to be more of a focus, especially on the institutional side.”