Billions flowing into bond ETFs are a bright spot for BlackRock

The bond craze is proving to be a godsend for BlackRock’s fixed income exchange-traded funds, which have attracted more investor money than all of their peers combined since the start of US interest rate hikes.

BlackRock, the world’s largest money manager, is capitalizing on growing interest from money managers and other money managers to use ETFs instead of, or in addition to, buying bonds directly. From March last year to the end of January, BlackRock’s fixed income ETFs netted $146 billion, compared to $134 billion for its competitors.

Fixed income ETFs were a bright spot for BlackRock after a year, as total assets under management shrank nearly 15 percent to $8.6 trillion. Chief Executive Larry Fink sees them as a key driver of revenue growth. BlackRock forecasts that industry-wide bond ETF assets will more than double from $1.8 trillion today to $5 trillion in 2030.

The increases are being driven by regulatory changes, growing investor confidence in their performance in volatile markets, and creative use by money managers and even other bond funds.

“There has been a significant shift in the way people think about fixed income ETFs over the past year,” said Deborah Fuhr, founder of ETFGI consultancy. “We’ve seen big funds and asset managers investing their portfolios in ETFs. . . instead of buying bonds and trying to manage them yourself.”

“It’s an ongoing trend. Once [people] once they have used an ETF, they use it more often and in different ways.”

Global Fixed Income ETF Net New Money ($bn) column chart showing that BlackRock benefits from inflows into fixed income ETFs

BlackRock entered the fixed income space ETFs early and has long been the largest player: it manages more than 40 percent of global assets in this category. But as competition for broad-based and retail-focused ETFs increased, it expanded into new areas. The number of bond ETFs on offer has almost doubled from 243 to 462 in the last five years.

“We are finding and expanding in all parts of the bond market in several different segments. . . Every part of the bond market that can be accessed through an ETF is covered by us,” said Salim Ramji, Global Head of ETF and Index Investments at BlackRock.

Narrow segments include ETFs like IBTG, which only holds US Treasuries maturing in 2026, or LQDB, which only holds BBB-rated corporate bonds.

This allows active fund managers to use them in a variety of ways. Some use a certain percentage to align their portfolio to either longer or shorter duration bonds based on their view of the economy. Others use BlackRock’s broad AGG index fund as a storage tank when they receive large inflows, allowing them to invest money immediately while giving their active managers time to buy the right bonds.

“We use ETFs because it is operationally quick and easy to do. It’s a quick way to gain exposure to a whole range of bonds,” said Wylie Tollette, chief investment officer of Franklin Templeton Solutions. If “you buy and sell the bonds directly, you pay an embedded commission. When you add up the round-trip commission on the bonds, the ETF fee is very cheap.”

Professional investors’ interest in bond ETFs really started to pick up after many oil and gas companies failed in 2015. Back then, shorting BlackRock’s high-yield bond ETF proved to be a better hedge against junk bond defaults than buying a credit default index swap, as the ETF more accurately tracked the high-yield bond market.

“We’ve started to get a lot of inquiries from real bond traders. . . Up to this point, ETFs have probably been more used by fixed income tourists,” said Samara Cohen, BlackRock’s chief investment officer for ETFs.

Regulatory changes have also spurred adoption: in December 2021, New York state regulators began allowing insurers to treat passive fixed income ETFs like bonds for the purpose of calculating capital requirements. This made the products more attractive to some of the industry, and other states have followed suit.

Ramji said BlackRock ETF users include nine of the top 10 active managers and eight of the top 10 US insurance companies.

Some money managers are skeptical of the trend, arguing that as active investors they find it difficult to put money into other companies’ passive funds.

“The allocation of fees to fees is a real problem internally,” said a portfolio manager at a large fund house, who did not want to publicly criticize his colleagues. “At that point we decided that the ‘costs’ did not outweigh the benefits.”

BlackRock’s closest competitor, Vanguard, has opted for a very different strategy. It has 48 fixed-income ETFs with $389 billion in assets, up from 38 with $150 billion in 2017. The Pennsylvania-based group, which mostly serves retail clients, said it chose to streamline its selection Adjust to reflect “investors’ preference for low-cost, broadly diversified fixed income ETFs”.

Line chart of assets under management ($Trillions) showing that fixed income ETF assets have more than doubled in five years

However, many fixed income investors say the growth of bond ETFs has fundamentally changed the market for the better because of their structure. ETF stocks trade on exchanges throughout the day, and more than 80 percent of bond ETF trades occur without the need to buy or sell the underlying securities, increasing liquidity.

Additionally, the market makers, who buy and sell the actual bonds that back ETFs, have become accustomed to the pricing of large pieces of security.

“Five years ago, when we wanted to sell $20 million to $25 million in corporate investments, we had to do it line by line. Now merchants can offer it as a block price,” said John Gentry, head of corporate fixed income group at Federated Hermes. “This has helped us find bonds that we couldn’t find before.”

According to Manuel Hayes, senior credit portfolio manager at Insight Investment, using ETFs can help reduce the cost of buying high-yield corporate bonds from around 60 to 80 basis points to 15 or 20 basis points. “ETFs are here to stay and they are evolving. If you miss it, you’re missing half the market,” he said.


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Adam Bradshaw

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