Fixed income ETFs continue to lure investors

Investors are returning to fixed income ETFs in their droves following a mass exodus earlier this year and yields dipping into negative territory.

According to data from Morningstar, fixed income ETFs saw €4.4bn inflows in August, up 70% in the same month last year and an increase of 80% on the previous six months when February saw just €2.4bn positive flows.

Yields continue to remain low and in many cases – such as developed market sovereign bonds – are negative. Despite current yields, however, the outlook may be rosier than first meets the eye.

Commenting on the low yields, Jose Garcia-Zarate, associate director, passive strategies, manager research, Europe, at Morningstar, said: “This may not be pleasing for the group of investors who depend on bond coupon income, but explains why the investment community as a whole has poured money into bond markets.

“The actual value of the bond holdings (i.e. the price of the bonds) has been going up and is likely to remain high as long as the central banks continue to keep interest rates this low.”

A consequence of central bank QE programs, and more recently the economic problems caused by the Covid-19 crisis, is bond yields are likely to remain suppressed.

One of the reasons that bonds are typically a home for investor money is that many central banks use US Treasuries as a safe place for their foreign currency reserves. The US Treasury market is the biggest and most liquid market in the world and the best place for these enormous reserves.

The central banks are also the biggest buyers of bonds because of QE. Regulation in the form of BASEL III requires some investors to have an allocation in bonds.

As Peter Sleep, senior investment manager at 7IM, explained: “For example, pension funds buy bonds to give a return without too much risk. Banks also buy bonds as it helps them to have liquidity; they do this by holding government bonds which can be sold easily to raise cash in times of trouble.

“This was introduced after the 2008 Global Financial Crisis when banks ran out of cash and had to be bailed out by their governments.”

According to the data, the fourth most popular bond segment in August was euro government bonds, with investors pouring €496m in.

Despite events this year, the most popular purchases last month were the RMB onshore bond ETFs with €903m flowing in, the segment has also had positive inflows since May 2019.

There are three ETFs available to investors in Europe; the Goldman Sachs Access China Government Bond UCITS ETF (CBND), the Xtrackers Harvest China Government Bond UCITS ETF (CGB) and the iShares China CNY Bond UCITS ETF (CNYB).

The Chinese bond market is increasingly being seen as a viable option for investors looking to diversify their government bond exposure.

Highlighting this, Invesco's 2019 Global Fixed Income Study found global investors had a strong interest in China’s fixed income market, with the majority of investors surveyed showing interest in making a strategic or thematic allocation to Chinese onshore bonds in the next three years.

The report stated: “China’s onshore bond market is the second largest in the world), but also its unique characteristics; compared to other major bond markets, Chinese onshore bonds have offered higher yields, lower currency volatility and greater diversification benefits.”

Returns from the RMB bond market are around 4% this year.

Other popular bonds were global bond US dollar hedged ETFs and US dollar corporate bond ETFs, which saw €835m in net inflows and €642m, respectively.

Corporate bonds were one of the biggest casualties earlier this year but they, and high yield bonds, are now seeing a positive return. They can work as an effective risk hedge.

Olivier Souliac, head of passive index strategy and analytics at DWS, said: “With Covid-19 and the subsequent Fed announcements around corporate bond purchases, investors flocked into fixed income assets and specifically corporate bonds to crystallise spread tightening and to reduce risk budgets. So far this year, corporate bond ETFs have had very high inflows, at around €12 billion in Europe.”

There are also other reasons to suggest why investors are returning to bonds, including the type of investment, easier access and lower costs.

“Investors have switched from self-managed, single bond portfolios into ETFs, while regulation around single bonds has made fixed income ETFs more attractive for retail investors,” Souliac continued. “TERs and trading costs are also going down due to scale, and this has made core investment grade and sovereign bond ETFs attractive as well. In this context, core fixed income ETFs are acting like magnets – the greater their size, the more they attract new investors.”

Despite this, investors are still caught between the high costs of downside protection with low risk budgets due to higher past volatility, and the fear of missing out on a continued equity market rally.

“We are seeing a rising consensus across the investment community that being prepared for bouts of volatility and holding through those phases can be a winning strategy, as long as diversification remains broad,” Souliac added.

Below is a non-exhaustive list of RMB onshore bond ETFs and US dollar corporate bond ETFs on the London Stock Exchange.

ETF

YTD returns

TER

Index

Goldman Sachs Access China Government Bond UCITS ETF (CBND)

3.27%

0.35%

FTSE Goldman Sachs China Government Bond Index

Xtrackers Harvest China Government Bond UCITS ETF (CGB)

4.28%

Mgmt Fee: 0.25%