Fixed-income exchange-traded funds have exploded in popularity over the past two years, but, unlike with equity ETFs, low costs aren't the main draw for advisers.
Fixed-income ETFs broke out in 2011 when they recorded inflows of $43 billion, more than double the amount from the year before. And they haven't shown any sign of slowing down since. Such exchange-traded funds had $39 billion of inflows year-to-date as of Sept. 30 — the most of any ETF asset class, according to Morningstar Inc.
While the popularity of equity ETFs has largely been driven by their low costs, advisers are drawn to fixed-income ETFs mostly because of their convenience and liquidity, according to a survey of 200 advisers by provider Guggenheim Investments. More than 70% of advisers cited those factors as the biggest advantage bond ETFs have over individual bonds or bond mutual funds, compared with just 16% that said cost was the biggest advantage.
The convenience and liquidity advantages of bond ETFs are most apparent when compared with the alternatives, said Bill Belden, head of product development at Guggenheim. “Individual bonds have costly spreads and mutual funds don't have the continuous pricing,” he said.
Much like equity ETFs, bond exchange-traded funds let advisers slice and dice the market to get the specific allocation they're looking for. And because the funds are traded intraday on an exchange, it's relatively easy to move in and out of a bond sector.
That liquidity does come at a cost, though, particularly in less liquid markets such as municipals and high-yield. When there's increased selling pressure, municipal bond and high-yield-bond ETFs tend to trade at premiums to their net asset value, much like a closed-end fund. So an investor looking for a quick exit may have to pay in the form of a higher transaction costs.
Those costs are still relatively lower than what the spreads would be in trading individual bonds, Mr. Belden said.
The focus on liquidity over fees is something of a surprise, particularly in light of the continuing ETF price war between some of the biggest providers.
BlackRock Inc., The Vanguard Group Inc., and The Charles Schwab Corp. have each gone tit for tat with cuts, or expected cuts, to their ETF fees over the last few weeks, though the cuts have primarily been aimed at equity ETFs.
BlackRock did slice the expense ratio of the $15 billion iShares Core Total U.S. Bond Market ETF Ticker:(AGG) to 8 basis points, down from 22. It's now 2 basis points cheaper than the $17 billion Vanguard Total Bond Market ETF Ticker:(BND).
Even with the growing popularity of bond ETFs, advisers are still having a hard time dealing with the low-interest-rate environment, which has resulted in both low yields and the risk of rising interest rates. More than 40% of advisers listed that as the main thing stopping them from adopting fixed-income ETFs.
The Federal Reserve reiterated Wednesday its goal to keep rates low until at least mid-2015.
“It's a big problem for those who are reliant on bonds for income,” Mr. Belden said.