Fixed-Income ETFs Growing Rapidly in Popularity and Type
The number and type of fixed-income exchange-traded funds is growing and the sector is providing an increasingly attractive alternative to fixed-income mutual funds and other investments.
In a new report Why 2007 Is ‘The Year Of The Fixed-Income ETF’ In The US, Standard Poor’s Credit Research says that Fixed-income ETFs are “spreading their wings by broadening their index base and venturing into active management.”
The number of funds has achieved a fivefold increase to about 30 from six over the past year. Since fixed-income funds currently represent only a small fraction of the total ETF count of roughly 550 available in the US (up from about 400 in 2006), they have substantial opportunity for growth, S&P says. “Indeed, scores of fixed-income ETFs are set to launch pending SEC approval.”
What began simply, with a fixed-income ETF tracking a US Treasury index in 2002, has evolved into offerings that include aggregate and corporate-debt indexes and slices of them, as well as ETFs that focus on municipal bonds or high-yield debt.
The ranks of fixed-income ETF sponsors have swelled, with Ameristock and Vanguard joining, and with offerings and funds from Powershares, Van Eck Global Advisors, and Bear Stearns in registration.
Municipal bond funds, which debuted in 2007, are laying the groundwork for the next generation of funds by “opening the door for actively managed ETFs.” Because bonds are generally considered more fungible than equities and the universe of municipal bonds is broad but not deep, ETFs invested in this area use very aggressive sampling, relying on as few as 30 or 40 bonds to track indexes containing thousands of fixed-income securities.
Some equity ETF sponsors are pushing the active management door open even wider, aiming to outperform their benchmark indexes or earn returns that are multiples of an index or are inversely correlated to it, S&P says. Even the index can be eliminated: An ETF can consist of the top picks of its manager. ETFs could also serve as a better vehicle for $310 billion in fixed-income mutual funds.
Standard & Poor’s has assigned investment-grade ratings to 25 of the ETFs it rates, with the majority in the most creditworthy ‘AAA’ range. Just one—a high-yield bond fund—carries a speculative-grade rating, obviously because it focuses on the higher returns that riskier below-investment-grade securities can generate. In addition to fund credit-quality ratings, Standard & Poor’s has assigned volatility ratings to the ETFs it reviews.
As for the future, institutional clients are asking for global and emerging market debt, and individual country debt is expected to follow.
The detailed report is available for purchase.
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