Five fund buyers highlight areas for fixed income ETF innovation

Tom Eckett

a group of men in suits

The fixed income ETF market is still very much in its infancy in Europe with investors crying out for new ways to slice and dice the asset class.

The market is dominated by broad-based ETFs which offer exposure to thousands of securities however there are times when investors need more specific exposure.

According to Tabula, the largest 30 ETFs account for just over 50% of the $239bn market meaning the space is ripe for disruption.

In the build-up to ETF Stream’s Fixed income ETF innovation: New ideas in a growing market webinar on 17 June, we asked five fund buyers the areas where they would like to see further innovation in a market that has the potential to see huge growth over the next five years.

Wayne Nutland (pictured left), head of managed index solutions at Premier Miton Investors

Further continued granularity in the bond ETF space would be welcome, however, spreads are often wider for bond ETFs than equity ETFs and this can undermine the case for more granular exposures, i.e. if a potential return difference is offset by transaction costs.

This is, of course, something of a chicken and egg situation, but it is important that new offerings benefit from tight spreads in order to enable investors to make use of them.

For many investors, currency hedging is important for bonds, particularly multi-currency exposures. Where TERs are higher for currency hedged share classes, the currency hedging costs would appear quite high in some cases.

Matt Brennan (pictured centre right), head of passive portfolios at AJ Bell

We have started to see government bond ETFs being split down into maturity buckets.

The ability to do this across credit ETFs would be a big step forward in convincing people that ETFs offer an alternative to active managers in this space, where credit duration is often the biggest driver of return (especially with yields so low).

This will allow portfolio managers to actively manage their fixed income asset allocations at a much more reasonable cost.

In addition, we feel extra features added to fixed income ETFs, such as additional liquidity filters or quality filters will help alleviate investors’ concerns that bond ETFs are skewed towards the most indebted companies and countries.

Iain Barnes (pictured centre left), head of portfolio management at Netwealth

We look forward to greater innovation in the ETF space of good value currency-hedged share classes of existing core ETFs.

We also think there are many more avenues to be explored in the creation of fundamental indices for fixed income ETFs to track.

Raymond Backreedy (pictured right), CIO at Sparrows Capital

There are a number of areas where we would like to see innovation in the fixed income ETF space.

On the product side, there needs to be more fixed income ETFs across the credit and maturity spectrum such as short, mid and long-duration government bonds hedged to sterling along with short and mid-duration investment grade corporate bond ETFs hedged to sterling.

ETF Insight: High yield points the way to fixed income ETF innovation

From a sustainable investing perspective, ESG-rated sovereign and corporates both hedged and unhedged would be an interesting development.

Finally, on the trading side, we would like to see more on exchange listing and trading of fixed income ETFs in different currency lines.

Weixu Yan (pictured centre), head of ETF research at Close Brothers Asset Management

Fixed income indices have traditionally followed in the footsteps of equity indices – constituent weights are based on market capitalisation.

With fixed income, however, this gives the highest weight to the company that has issued the most debt. In an ETF this means the investor buys the debt of the company that issued the most.

With equities, you could argue that the higher the market capitalisation, the better the company. However, with fixed income that might not be true – the company issuing the most debt might not be doing that well.

In terms of innovation, it would be good to see some robust, well thought out fixed income indices that are investor friendly. This could be an ETF that has a finite lifespan like most of the bonds.

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