Despite representing just 18% of total assets in U.S.-listed ETFs, fixed income ETFs have pulled in a whopping $42 billion so far this year, equal to 55% of the industry’s net inflows thus far in 2019.
This has occurred even as interest rates declined, reflecting a more patient Federal Reserve, and risk-taking being rewarded in the equity markets. Indeed, some of the largest government and other investment-grade-focused fixed income ETFs gathered assets in 2019.
Yet the largest inflows occurred across vastly different products, which we think highlights how ubiquitous bond ETFs have become.
Taking On More Risk
Four of the 10 ETFs seeing the largest net inflows as of April 25, according to data available from ETF.com, were in the fixed income category:
Source: ETF.com; YTD through 4/25/2019
Last year, ultra-short-term and short-term Treasury bond ETFs were the most popular products, as investors sought the safety and liquidity of the investment style without taking on much interest rate risk. In contrast, investors in 2019 have been more willing to take on some additional interest rate and/or credit risk.
TLT pulled in $4.1 billion in new money so far in 2019, with half of that coming in during the prior week. While TLT is one of the oldest ETFs, launching in mid-2002, this year’s cash infusion has only pushed its asset base to $13 billion.
The ETF still remains smaller than many younger products, likely because of the risk it intentionally incurs. Though its credit profile is very strong, the ETF’s average duration of 17 years is among the highest available.
TLT declined 1.6% in 2018, but has recovered in 2019, with a 2.2% gain. Even as flows picked up in April, for the past six months, liquidity has been strong, as TLT has averaged $1 billion in volume daily. The ETF also has a modest 0.15% net expense, helping its CFRA rating.
VCIT launched in late 2009, and was the second-most-popular fixed income ETF this year. With its $4.0 billion net inflow, the fund now has $23 billion in assets. We think some of these inflows stemmed from a coordinated $1.5 billion rotation away from the Vanguard Intermediate-Term Bond Index ETF (BIV).
Relative to BIV, VCIT incurs a similar level of less interest rate sensitivity—average duration of six years—but VCIT investors are compensated with a higher 30-day SEC yield (3.9% for VCIT versus 3.1% for BIV).
As a partial offset, the investment-grade credit quality is weaker. VCIT holds mostly corporate bonds rated A and BBB rather than having just over half its assets in higher-rated Treasury and agency bonds. Bank of America, Citigroup and Morgan Stanley were some of the largest issuers.
VCIT was up a strong 5.7% thus far in 2019, after a 1.7% loss in 2018. VCIT’s 0.07% expense ratio is among the lowest in the industry, but the fund’s $125 million average daily value traded makes this a little less liquid than some.
MBB has been around since 2007, and now has $16 billion in assets, aided by a $3.6 billion net inflow so far in 2019. MBB holds high-investment-grade-rated FNMA, GNMA and FHLMC bonds, and has an average duration of 3.5 years, making it the least-interest-rate-sensitive of the quartet of ETFs profiled.
MBB charges a low 0.09% net expense ratio, and traded $131 million on average in the past six months. After rising 0.8% in 2018, the fund was already up 1.8% in 2019.
BNDX launched in mid-2013, and has $17 billion in assets under management, aided by 2019’s $3.3 billion infusion. BNDX similarly holds investment-grade bonds like BIV, but the issuers are mostly foreign governments and corporations rated AA and A that provide geographic diversification; exposure is greatest from Japan, France and Germany. BNDX’s average duration is nearly eight years, and yet the 30-day SEC yield is below 1.0%, hurting its reward/risk profile.
Thus far in 2019, the fund, which charges only 0.09% expense ratio, is already up 2.7%, after a similar 2.8% gain for all of 2018. Volume has picked up recently, and BNDX has traded $127 million shares daily in the last six months. BNDX’s rating from CFRA is hurt by its below average yield and liquidity, as well as its above average duration. The ETF’s low expense ratio and bid/ask spread don’t provide a sufficient counterbalance.
This article was originally published on MarketScope Advisor on April 29, 2019. Visit www.cfraresearch.com for more details.
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