March 17, 2011

Aite Says Fixed-Income ETFs Are Poised for Explosive Growth

BlackRock, State Street Global Advisors and Vanguard dominate about 85% of the ETF industry

Fixed-Income ETFs Have SoaredA new Aite Group report released Wednesday says equity-based exchange traded funds may be the dominant asset class in the ETF universe, but fixed-income ETFs also have shown explosive growth over the last five years and are poised for even more.

“Fixed-income ETFs are just getting started,” wrote Aite senior analyst John Jay in an 18-page impact note, Fixed Income ETFs: Just Another Fad, or Here to Stay? “Their cost-effectiveness and strategic financial and tactical investor appeals are very compelling, and duration, credit, sector and relative value plays are no longer out of reach for many.”

Overall trends in the financial-advisor industry are in favor of increased ETF usage, driven by regulatory pressures and increased attention on developing retail client education and investment needs, Jay noted.

The development of specialized ETFs, both passively and actively managed, means that financial advisors are giving these funds closer consideration for use in client portfolios, Jay (left) said. He argued that the three factors contributing to advisors’ use of fixed-income ETFs are:

  • Operating under a common fiduciary standard
  • Education of advisors and investors through wholesaling and analytical tools
  • Generating portfolio returns based on macroeconomic positioning

“These factors will accelerate ETF utilization and cannibalize the existing mutual-fund-dominated, advisor-distributed, investment-management market,” Jay wrote.

Until 2006, the Securities and Exchange Commission had reservations about a potential lack of liquidity with fixed-income ETFs because, Jay pointed out, “it is much more difficult to short bond issues than it is to short publicly traded equity issues.”

But as the ETF universe continues to grow and many funds are now actively managed, the SEC’S comfort level with fixed-income ETFs has increased.

As a result, according to the Aite report, fixed-income ETF assets under management have grown threefold from 2008 through 2010, reaching 15% of total ETF AUM, or about 120 funds.

Equity continues to be the dominant asset class, but U.S. exchange traded fund (ETF) inflows reached $6.8 billion in February and ETF industry assets totaled nearly $1.1 trillion at the end of February. This gain marked a month-over-month increase for the sixth consecutive month, Morningstar reported Monday.

Though fixed-income ETFs have room to grow, “they do have some natural hurdles to surmount,” Jay said. These hurdles include:

High initial capital infusion. BlackRock, State Street Global Advisors and Vanguard dominate about 85% of the ETF industry, accounting for roughly six out of every seven ETFs.

A substantial amount of time to conduct proper due diligence. The SEC can take more than six to nine months to decide whether to approve an ETF’s issuance. “In short, this is not a quick-to-market endeavor,” Jay said.

Not every segment of the fixed-income market is ready for ETFs. For example, Jay noted, Vanguard in January withdrew its application from the SEC to issue municipal bond ETFs after U.S. Treasury long rates skyrocketed.

“There are innumerable ways in which to express investor views through the fixed-income markets,” Jay wrote. “ETF sponsors, long aware of this, are pushing hard to create other ETFs to meet investor needs.”

Read about Aite Group’s report on the best software for advisors at AdvisorOne.com.

Page 1 of 2
Single page view Reprints Discuss this story
This is where the comments go.