Tags: ETF | bonds | investors | institutions

Bond ETFs Swell in Size and Risk as Institutions Pile in

Thursday, 12 Jun 2014 02:24 PM

Institutional investors having trouble finding bonds for their portfolios from the usual suppliers are accepting a higher degree of risk and pumping billions of dollars into exchange-traded bond funds, boosting asset management firms such as BlackRock, Pimco and State Street.

Wall Street banks are holding fewer corporate bonds these days than they did before the 2008 financial crisis, the result of pressure from global regulators to take less risk. Primary corporate bond dealers are holding only $57 billion in individual bonds compared with $250 billion pre-crisis, according to the Federal Reserve Bank of New York.

The relative lack of liquidity makes it harder and more expensive to buy and sell individual bonds on the secondary market and is sending portfolio managers like Thomas Anderson, who oversees almost $5 billion in assets as chief investment officer of Boston Private Bank & Trust Company, to ETFs for his clients, who include wealthy individuals and nonprofit groups.

"Wall Street's pullback has made buying bonds a little more challenging," Anderson said. "The supply is there, but it may not be exactly what you want. You may get the right issuer, but not the maturity structure or the amount that you want. We use ETFs to plug in the holes."

Investors have made net deposits of $22 billion in ETF bond funds so far this year, bringing their total assets to $410 billion, according to Lipper Inc. and research firm ETFGI. Junk-bond ETFs swelled $4.3 billion to $55.3 billion, after rising $10.6 billion in 2013, according to ETFGI.

The $4.2 billion SPDR Barclays Short-term High Yield Bond ETF has received $2.7 billion in net deposits from investors over the past year, according to Lipper Inc., a unit of Thomson Reuters. Mutual funds owned 7 percent of the ETF's shares at the end of 2013, according to Thomson Reuters data.

Institutional investors and registered investment advisors accounted for 97 percent of the net new business in BlackRock's $14 billion iShares iBoxx $ High Yield Corporate Bond ETF so far this year, the company said. More broadly, almost one-third of large dealer banks reported that bond ETF use was on the rise among institutions, according to a Federal Reserve survey released in January.

"The only way to get a big position now on the high yield bond market or on the emerging markets bond market, if you want to do it within a week is through ETFs," said Daniel Gamba, a BlackRock executive who deals with institutional investors.

In some spots, ETFs exceed the assets held in the individual bond market. Corporate junk bond ETF assets, for example, were $36 billion at the end of the first quarter, or about five times more than similar inventories held by Wall Street banks, according to Fitch.

"Although high-yield ETF trading remains small relative to the entire high-yield bond market, its significance has increased as the volume of trading in the underlying market has fallen," Fitch Ratings said in a report released Wednesday.

Goldman Sachs Group Inc., for example, has reduced its capital-intensive corporate bond inventories, Bernstein Research analyst Brad Hintz said in a recent research note.

While U.S.-listed corporate-bond ETFs hold $106 billion, or about 1 percent of the debt in the $10 trillion U.S. corporate bond market, the relatively new products still pose some risk not usually associated with bonds.

RISKS FOR INVESTORS

ETFs, like stocks, trade constantly throughout a trading day and their value can fall more dramatically than the underlying bonds that they hold, said Brian Callow, director of fixed income at Rockland Trust, a Massachusetts bank with $6 billion in assets. By contrast, some individual bonds don't trade for days or weeks, leaving them less susceptible to redemption mood swings that can hit an ETF.

"One problem I see out there is headlines," Callow said, referring to news that affects the bond market. "Investors have to remember the short-sightedness of headlines. There are periods when ETFs work and when they don't."

Last summer, amid bond-market concern about a potential shift in Federal Reserve policy over interest rates, a cross-section of junk bond ETFs showed price volatility by trading more than 0.5 percent outside their net asset value. That highlights the potential for price dislocations to develop during market turmoil, said Robert Grossman, a managing director at Fitch Ratings.

At the same time, the deviation of an ETF from the value of the underlying bonds during the day could lead to real-time price discovery for the fixed-income market, which otherwise trades with a much longer time lag.

"Fixed-income is both opaque and illiquid," said Elisabeth Kashner, director of research at analytics firm ETF.com, noting that there is little transparency in traditional bond pricing because most bonds, which trade over-the-counter, don't trade every day. ETFs, on the other hand, can better reflect investor behavior because, like stocks, they trade every day.

BLACKROCK, PIMCO

The rise in ETF popularity is helping BlackRock Inc., State Street Corp. and Pimco attract assets from insurance companies, pension funds, hedge funds and other institutional managers.

BlackRock, the world's largest ETF provider with some $200 billion in fixed-income assets, said institutional investors account for a growing part of the firm's net new business. Its iShares unit has launched some 20 new U.S.-listed fixed-income ETF products over roughly the past 18 months. BlackRock also has put together special teams to focus on ETF sales to specific institutional client segments, including asset managers, hedge funds and insurance companies.

At State Street's asset management arm, State Street Global Advisors executives are seeing big buys of bond ETFs from some institutional managers.

"We've had $500 million to $1 billion investments in bond ETFs" from a single institutional investor, said State Street's Brian Kinney, who oversees ETF portfolio managers in Boston, London, Singapore, Sydney and Tokyo. "Pensions and endowments and other asset managers are very sensitive to transaction costs. They've come to see ETFs as a viable option to make sector bets."

© 2017 Thomson/Reuters. All rights reserved.

 
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Institutional investors having trouble finding bonds for their portfolios from the usual suppliers are accepting a higher degree of risk and pumping billions of dollars into exchange-traded bond funds.
ETF, bonds, investors, institutions
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2014-24-12
Thursday, 12 Jun 2014 02:24 PM
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