In April, BlackRock launched a three-year, fixed-income ETF called iSharesBond 2016 Investment Grade Corporate Bond ETF(IBCB) with $10 million. Just four short weeks later, the ETF has attracted an additional $5 million in investments. IBCB is one of four in a series of fixed-maturity ETFs that have attracted an additional $20 million in investments overall.
“It confirms that more money is flowing into shorter-term, fixed-income ETFs,” said Matt Tucker, head of iShares fixed-income investment strategy at BlackRock, who was a speaker at a BlackRock’s press conference last week regarding ETF use among institutional investors.
About $11 billion went into short-term bond ETFs over the past year, according to Morningstar. That’s compared to $6.7 billion a year ago. Investors increasingly are concerned about duration risk, which indicates how much a bond will fluctuate in price when interest rates go up or down. The higher the duration, the greater the bond’s sensitivity to interest rate changes. And that can have a direct impact on the value of a fixed-income ETF.
“Many investors are concerned with duration risk in long-term treasuries and other fixed-income vehicles, said Andy O’Rourke, a managing director with Direxion. “The natural reaction is to take an even more conservative approach and seek shelter with short-term, fixed-income vehicles.”
He added this indicates that investors still aren’t ready to plunk a significant amount of their assets into the equity markets, so they’re taking an ultra-conservative stance in the fixed-income space out of fear that interest rates will increase.
“When interest rates rise the value of principal decreases,” said Noah Hamman, CEO of AdvisorShares Investments, which launched its two-year duration Newfleet Multi Sector Income ETF (MINC) two months ago with $5 million in assets. The fund now has $78 million in assets and is invested in corporates, international corporate debt, Treasuries and mortgage backed securities.
“The main appeal of short-term, fixed income ETFs are their lower duration and opportunity for lower loss of principal risk,” Hamman said.
According to BlackRock, the flows into its intermediate fixed-income iShares iBoxx $ Investment Grade Corporate Bond Fund (LQD) with an average eight-year duration has been negative $1.2 billion compared to positive flows of $1.2 billion into its three-year iShares Floating Rate Note Fund (FLOT).
“Like many other fixed-income investments, if people invest in a short-term duration ETF they will be better protected against rising interest rates but the trade-off is less yield in return,” Tucker said.
With duration of three months, BlackRock’s FLOT ETF has yielded 58 basis point compared to LQD’s 2.93 percent yield. “Investors are moving out of ETFs like LQD because even though they offer more yield there is concern about rising interest rates,” Tucker said. “These two ETFs are a good example of the relative yield trade-off investors are making and where the flows are year to date. In today’s market, people are more comfortable taking on credit risk and investing in corporate bonds and less comfortable taking on duration risk and investing in long-term duration investments.”
Six-month Treasury bills are yielding eight basis points compared to 1.89 percent for 10-year Treasuries. “Options appear to be limited within the traditional asset classes, which is exactly why we educate advisors and investors about using alternative asset classes and strategies, such as managed futures, commodities and currencies,” O’Rourke said. “If used properly, these strategies can help diversify portfolios and seek potential revenue streams away from traditional asset classes.”