Exchange-traded products focusing on fixed-income assets can overcome the largest challenges facing today’s bond markets.
The role of fixed income in multi-asset portfolios is evolving with the unprecedented levels of market volatility we have seen this year, and it is hard to think of a better time to rethink fixed income.
In today’s fixed-income markets, investors face increasing pressure to deliver returns, generate yield and maintain diversification. To do so, we believe there is a need to move beyond the outdated “active first and only” fixed-income approach and consider indexing and fixed-income ETFs. The best way to understand just why ETFs are suitable, is to consider how they can help address the main challenges in today’s bond markets. We see four big challenges.
Resilience through diversification
Firstly, the endless search for yield has reduced resilience. As yield becomes increasingly scarce, investors are allocating to riskier asset classes.
This increase in exposures exacerbates credit spread risk.
Such allocations also reduce the diversification benefits of bond portfolios by giving them higher correlation to equity markets – in particular during market downturns. Indexing and ETFs offer investors transparency and clarity on portfolio exposures and risks in fixed income because of their rules-based approach.
Moreover, they serve as efficient building blocks that could bring resilience to investors’ fixed-income allocation through diversification, in a cost-effective way that also saves time.
Help to protect portfolio from currency fluctuations
Another challenge is the impact of currency fluctuations on overall performance. Foreign exchange is the largest risk in multi-asset portfolios, after equity risk. ETFs benchmarked to fixed-income indices, especially those with a global focus, could help with this, offering various currency-hedged share classes across exposures including Sterling, dollar, euro, krona, and Swiss francs.
The third challenge is investors’ discovery that their portfolios lack flexibility. As market volatility soared in March 2020, many investors discovered their fixed-income allocations lacked the liquidity, price discovery and flexibility they needed to de-risk. Investors need nimble, liquid fixed- income exposures that remain liquid even during volatility. Through ETFs, investors can price whole sections of the market and make informed decisions in real time.
The final challenge is sustainability. Interest has been on the rise in recent years, 2019 saw a 13% increase in allocations to sustainable fixed income as more investors seek ways to navigate the bond market with a sustainable lens. Investors also want a transparent and scalable implementation approach.
To conclude, bond investors face challenges. Fixed-income ETFs could help investors address these. As multi-asset investors rethink the role of fixed income in their portfolios and address today’s portfolio construction challenges, we see an even greater role for fixed-income ETFs now and in future.
Brett Olson is the head of BlackRock’s iShares fixed-income ETFs in Europe, the Middle East and Africa.