A major contradiction seems to have emerged in respect of investment into bond exchange-traded funds.

As Asian asset owners, fund houses and wealth managers ramp up exposure to ETFs, fixed income products are attracting particularly strong interest – even as many are expressing worries about the liquidity of bonds underlying such funds. 

Four in 10 respondents polled by research house Greenwich Associates* plan to increase allocations to bond ETFs in the coming year (and none to reduce them). Moreover, the share of ETFs in their fixed income portfolios have risen strongly to 26% in 2018 from 17% in 2017 and 6.6% the year before.

Meanwhile, a survey to be released today by US custody bank Brown Brothers Harriman** (BBH), found that 59% of Greater China investors (fund managers, asset owners and financial advisory firms) would buy fixed income ETFs in response to elevated market volatility. This was the most popular answer to the question of how they would use ETFs during a period of heightened market volatility.

In addition, bond and US equity products are the ETFs they would most like to see more of on the market, according to the BBH research.

Globally fixed income ETFs have seen net inflow of $56.4 billion this year as of end-March and $107.5 billion last year, contributing to a total of $940.2 billion held these products as of March 31, according to research firm ETFGI.

LIQUIDITY CONTRADICTION

It is the lack of fixed income liquidity driving this demand, say investors polled, yet by the same token it also worries them when investing in such products.

The Greenwich research shows that three-quarters of respondents choose liquidity as the main reason for using bond ETFs, followed by quick access (63%) and low management fees (56%).

However, Greater China investors cited liquidity of underlying bonds as their biggest concern when buying fixed income ETFs, with 34% citing this factor over, for instance, tracking error or expense ratio, found BBH (see graph below). The figure rose to 45% among mainland Chinese investors alone, potentially highlighting the liquidity challenges they face from corporate bond defaults.

LIQUIDITY THE MAIN CONCERN FOR BOND ETF INVESTORS
(Click for full view; Source: BBH)

Ultimately, if investors are increasingly buying fixed income ETFs because they feel such products are more liquid than the underlying securities, they must take into account that providers will be facing the same issues. This is an issue that has many market participants and industry observers worried.

These findings have also come as the International Monetary Fund warned last week of the potentially “destabilising effects” of passive, index-driven investment on emerging markets in the event of a sudden dash for the exits.

Meanwhile, contrasting views on fixed income ETFs are clear from conversations with individual asset owners in Asia.

Taiwan’s biggest insurance firm, Cathay Life, aims to boost its exposure to fixed income ETFs, but its local regulator has urged large insurers to review the liquidity of their bond ETF stakes.  

Paul Sandhu

Experts have also voiced concern that bond ETFs may not be sufficiently agile in more niche markets, as the levels of liquidity are different from those in developed markets like the US.

Bond ETFs with less liquid underlyings will drive up costs, defeating the purpose of them being a cost-efficient way to deliver returns, Paul Sandhu, head of multi-asset quant solutions and client advisory for Asia Pacific at BNP Paribas Asset Management, told AsianInvestor.

“Throw these bond ETFs into the local Asian marketplace and the costs rise even more,” he said.

Moreover Min Lei, head of financial risk management for Asian markets at French insurer Axa, said at a forum in November she was hesitant to invest in bond ETFs. She cited issues such as possible mandate mismatches between fixed income ETFs and an insurance company’s liabilities, and the potential for sizeable tracking error.

*The study by Greenwich, commissioned by BlackRock and released last week, is based on interviews with 51 Asian institutions, including institutional funds such as corporate pension plans (27%), insurers (35%) and investment managers (37%).

**The BBH report was released on April 15 on ETF usage by Greater China investment professionals. Of the 100 surveyed, financial advisers accounted for 61%, institutional investors 27% and fund managers 12%.