Institutional investors having trouble finding bonds for their portfolios from the usual suppliers are accepting a higher degree of risk and pumping billions of dollars into exchange-traded bond funds, boosting asset management firms such as BlackRock, Pimco and State Street.
Wall Street banks are holding fewer corporate bonds these days than they did before the 2008 financial crisis, the result of pressure from global regulators to take less risk. Primary corporate bond dealers are holding only $57 billion in individual bonds compared with $250 billion pre-crisis, according to the Federal Reserve Bank of New York.
The relative lack of liquidity makes it harder and more expensive to buy and sell individual bonds on the secondary market and is sending portfolio managers like Thomas Anderson, who oversees almost $5 billion in assets as chief investment officer of Boston Private Bank & Trust Company, to ETFs for his clients, who include wealthy individuals and nonprofit groups.
"Wall Street's pullback has made buying bonds a little more challenging," Anderson said. "The supply is there, but it may not be exactly what you want. You may get the right issuer, but not the maturity structure or the amount that you want. We use ETFs to plug in the holes."
Investors have made net deposits of $22 billion in ETF bond funds so far this year, bringing their total assets to $410 billion, according to Lipper Inc and research firm ETFGI. Junk-bond ETFs swelled $4.3 billion to $55.3 billion, after rising $10.6 billion in 2013, according to ETFGI.
The $4.2 billion SPDR Barclays Short-term High Yield Bond ETF has received $2.7 billion in net deposits from investors over the past year, according to Lipper Inc, a unit of Thomson Reuters. Mutual funds owned 7 percent of the ETF's shares at the end of 2013, according to Thomson Reuters data.
Institutional investors and registered investment advisors accounted for 97 percent of the net new business in BlackRock's $14 billion iShares iBoxx $ High Yield Corporate Bond ETF so far this year, the company said. More broadly, almost one-third of large dealer banks reported that bond ETF use was on the rise among institutions, according to a Federal Reserve survey released in January.
"The only way to get a big position now on the high-yield bond market or on the emerging markets bond market, if you want to do it within a week … is through ETFs," said Daniel Gamba, a BlackRock executive who deals with institutional investors.
In some spots, ETFs exceed the assets held in the individual bond market. Corporate junk bond ETF assets, for example, were $36 billion at the end of the first quarter, or about five times more than similar inventories held by Wall Street banks, according to Fitch.
"Although high-yield ETF trading remains small relative to the entire high-yield bond market, its significance has increased as the volume of trading in the underlying market has fallen," Fitch Ratings said in a report released Wednesday.