Why fixed-income ETFs have taken the industry by storm

Why fixed-income ETFs have taken the industry by storm

Why fixed-income ETFs have taken the industry by storm

So far in 2019, fixed-income ETFs have dominated the story. In July alone, Canadian fixed-income ETFs saw inflows of $1.5 billion, which represented 83% of all flows during the month and one of the highest months for fixed-income inflows in history. Fixed-income ETFs’ current popularity stems from a number of reasons, including the fact that they offer more diversification and exposure than single-issue bonds at an attractive price, with the added value of increased liquidity.

One person who has observed the changes in the fixed-income ETF space firsthand is Kevin Gopaul, BMO’s global head of ETFs. BMO has been a leader in fixed-income ETFs, recognized in the top 10 globally, and has introduced several innovations to the Canadian marketplace, including a discount bond ETF that maximizes tax efficiency and Canada’s first high-yield bond ETF.

Gopaul, who recently wrapped up his term as chair of the CETFA, says fixed-income ETFs have come a long way in a short amount of time.

“We always have a lot of inquiries around fixed income,” he says. “Fixed income has always been essential for risk management, portfolio diversification and income generation across all investor types. While fixed-income products are essential portfolio construction tools, there has often been a level of opacity around pricing, bid-offer spread and general accessibility. The emergence of fixed-income ETFs has improved access and efficiency to the asset class.”

The outlook hasn’t always been so good for fixed-income ETFs. Gopaul remembers the challenges the product had just a few decades ago, when brokerage houses classified them as equities simply because they were an ETF.

“There was also a time where market-makers had difficulty with fixed-income ETFs, pricing them and having proper bid-offer spreads,” he says. “It has come a long way – now there are products that cover all segments of the global fixed-income market. There is smart beta, active management, and with it all coming together, it has improved the market for fixed-income ETFs.”

Gopaul points to three reasons why fixed-income ETFs have seen a surge in popularity, especially recently. “I think the first is a general movement from single-issuer exposure to diversified strategies,” he says. “The second is the current market conditions, where the need for yield is as insatiable as ever. Finally, the breadth of offerings – there has been so much innovation in fixed-income ETFs, more than pooled or mutual funds.”

In regard to the movement away from single issuers, Gopaul points out that more and more investors are trading in a single corporate bond for an ETF in order to gain access to a collection of issuers. In addition, the creation of corporate bond ladders has resulted in better diversification and potentially better outcomes for advisors when building portfolios.

As for market conditions, because many experts believe that the current economic cycle is entering its later stages, Gopaul feels more money will continue to flow into fixed-income ETFs to lower risk. With more products out there, the choice for satisfying investors’ needs has never been greater.  

Gopaul notes that fixed-income ETFs give advisors an opportunity to simplify things for clients, in addition to their other benefits. “Fixed-income trading, pricing and accessibility has always been challenging for the vast majority of the population. Buying a fixed-income ETF can give you the exposure and efficiency at an attractive price – I think that is a key factor. With one purchase, you can have access to hundreds of issuers.”

He also believes the access to professional management appeals to advisors. “There are only so many levers a fixed-income manager can pull to add value: credit, sector, duration, maybe geography. It becomes difficult to show added value. So fixed-income ETFs give you exposure at the price you want. The quality of the manager is becoming key, so large-scale investment managers gain better pricing, insights and access to issues.”

Liquidity is another factor advantage of fixed-income ETFs. “Diversification can lead to better liquidity,” Gopaul explains. “Instead of one to four lines in your fixed income portfolio, you can have many more. That improves liquidity, as selling a larger number of smaller pieces of bonds is easier than selling the same dollar amount in one bond. Additionally, it lowers risk, improves diversification and improves portfolios.” 

With so many products available, Gopaul stresses that advisors need to know what they’re purchasing. “Understand what your client’s needs are, whether income, portfolio diversification or other, and find the product that matches,” he says. “It is an area where there’s a need for more information, so aligning with high-quality managers who can give you the support you need, with the offerings you need and at the right price, is important.”

Having a good understanding of products is also one of the greatest challenges with fixed-income ETFs, Gopaul says, as managers continue to launch new products with different outcomes. “As the outcomes become more customized,” he says, “you have to understand what you are getting and make sure it suits you.”

Going forward, he adds, “I think fixed income is going to become more precise, with more specific exposures – for example, just AAA or BBB bonds. The more discussions we have, the more we understand people’s needs and how they differ between clients.”

He also predicts an increased presence of active management in fixed income. “There are good active managers in the marketplace who understand the ETF wrapper opens a new distribution channel,” Gopaul says, “so I think we’ll see more active in the near future.”

This communication is intended for informational purposes only and is not, and should not be construed as, investment, legal or tax advice to any individual. Particular investments and/or trading strategies should be evaluated relative to each individual’s circumstances. Individuals should seek the advice of professionals, as appropriate, regarding any particular investment.

BMO Global Asset Management is a brand name that comprises BMO Asset Management Inc., BMO Investments Inc., BMO Asset Management Corp., BMO Asset Management Limited and BMO’s specialized investment management firms. ®/™Registered trade-marks/trade-mark of Bank of Montreal, used under licence.