Institutions Turn to ETFs for Bond Market Liquidity

Diminished liquidity in global bond markets is fueling demand for fixed income exchange-traded funds.

Because global bond market liquidity has diminished, institutional investors are investing more in fixed income exchange-traded funds (ETFs), according to Greenwich Associates.

Challenges in trading, liquidity and security sourcing are particularly pronounced in Europe, where 78% of institutions say this is a problem. Sixty percent of all institutions say that over the past three years, it has become difficult to execute large bond trades. More than two-thirds of respondents to the survey say these challenges are impacting their investment management processes.

This is why 60% of institutions have increased their usage of bond ETFs, with this asset class now comprising an average of 18% of their portfolios.

“A majority of institutions around the world now consider bond ETFs as an alternative for fixed-income exposure and liquidity,” says Greenwich Associates Managing Director Andrew McCullum.

Institutions that are investing more in bond ETFs say they allow them to obtain narrow and broad fixed-income exposures in both high-level strategic functions and targeted, tactical allocations.

One-third of current ETF investors plan to increase their bond ETF allocations over the next 12 months. In this U.S., this is 30%, and in Europe, 19%.

“Based on those results and investors’ continued concerns about bond market liquidity, Greenwich Associates expects steady and, perhaps, even accelerating growth in bond ETF usage and investment among U.S. and European institutions for the next three to five years,” McCollum adds.

A previous report by Greenwich Associates suggests ETF trading practices on both the sell side and buy side are leading to suboptimal executions, limiting ETF use. In addition, Greenwich found 41% of institutional investors are using ETFs to maintain exposure to a liquid investment, and 29% are doing so to meet potential cash flow needs.