To what extent will greater volatility in the world’s fixed income markets be a driver for more investment in smart beta ETFs?
That is one of the questions posed by the findings of the recent EDHEC investor survey which suggested that fixed income was a key area where investors are demanding more diversity of products.
As Lionel Martellini, professor of finance at EDHEC Business School, says “the more volatile the markets are, the more interesting it is to use low cost instruments for tactical allocation”.
Of course, the greater choice afforded by ETFs has increased the more the products diverge from ‘simple’ broad market tracking.
“ETFs, which originally replicated broad market indices, are now available in a wide variety of asset classes and market sub-segments and allow portfolio diversification. Investors can easily increase or decrease their portfolio exposure to a specific style, sector, or factor at lower cost with ETFs,” says Martellini.
In fact, it becomes something of a virtuous circle; as the diversity of ETFs increases, so the greater the possibility of using ETFs for tactical allocation. It goes some way to answering the fears regarding a ‘bubble’ in passive; not all the money from ETFs is piled into passive funds anyway.
This is regardless of the fact, as Martellini says, that with just 9% of the market in Europe, ETFs “do not yet dominate the market and their impact on the market is proportional to the market share they represent”.
But what can we surmise from this survey in what comes next in ETFs? As Martellini points out, in realty the percentage of ETF users for fixed-income asset classes has been rather stable since 2015.
Year-on-year, the increase in ETF usage of government bonds rose from 60% to 66% from 2018 to 2019 while with corporate bonds that percentage rose from 64% to reach 68%, according to the EDHEC 2019 survey.
In terms of the density of ETF fixed-income asset class investment, Martellini says the survey shows the average percentage of total investments accounted for by ETFs, the percentage for fixed income as a whole – both corporate and government bonds – stood at around 28% for the year.
But as he adds: “Concerning smart beta for fixed-income, there seems to be more room for an increase in investment in the near future.”
"Only 13% of our 2019 survey respondents declare using smart beta and factor investing for fixed-income,” comments Martellini. “However, it is for the fixed-income class that the survey respondents most claim the needs for additional developments of smart beta strategies.”
According to Martellini, the gap between the degree of interest in these products and a potential increase in the amount of money that is invested via them is due to a lag in terms of the offerings being put forward.
“There is still a gap,” he says. “This investment will develop in the near future, as soon as the offer matures and better matches investors' needs.”
Moreover, even when the products are available, the figures over the interest in these types of products should be tempered by the experience with equity ETFs. As Martellini explains, “the number of people investing in smart beta for fixed-income will probably increase faster than the share each one dedicates to this investment.”
As he points out, the survey found that 73% of all respondents invest less than 20% of their total investment in these products for the fixed-income class. This is very much which is comparable with the 70% of respondents who invest less than 20% of their total investment in these products for the equity class where, as Martellini concludes "smart beta for equity is a more mature market".
