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Fixed income exchange-traded funds (ETFs) enjoyed a boom last year as cost-conscious investors sought yield amid weak equity markets. By the end of 2011, fixed income ETF assets stood at $12 billion, a 43% rise from the end of 2010, according to Investor Economics.
The number of funds also increased dramatically—about two-thirds of the category’s 55 funds were launched in the last two years and 26 new fixed income ETFs were created in 2011.
“There’s definitely been a surge in ETF assets,” says Sandeep Gosal, senior analyst, Investor Economics. “During the market downturn of 2008, we started to see a lot of money going into money market funds. But as yields started to drop closer to zero, you started to see an increase towards fixed income funds.”
ETF giant iShares—which manages the bulk of ETF assets in Canada and whose parent company BlackRock bought rival Claymore in January—says Canadian ETFs took in $7.9 billion in net new assets in 2011 and of that, over 40% or $3.3 billion went into fixed income ETFs.
There are several reasons why fixed income ETFs have become popular with investors, the most obvious being cost.
As of the end of 2010, fixed income ETFs had an asset-weighted MER of 31 basis points, according to Investor Economics. Fixed income ETFs that pay a trailer to advisors had an MER of 79 basis points.
By comparison, actively managed fixed income mutual funds had an average asset-weighted MER of 138 basis points, which includes a trailer fee. Stripping out the trailer, the MER averages 74 basis points.
“Investors are voting with their dollars,” says Mary Anne Wiley, managing director and head of iShares for BlackRock Canada. “In a low yield environment, the more you can reduce your cost, the more you’ll have in your portfolio or your pocket,”
Gosal notes that there is also a brokerage cost associated with ETFs, essentially a trading fee ranging from $5 to $30 per trade. “That’s another consideration to keep in mind when looking at and comparing fees between ETFs and mutual funds.”
For the vast majority of investors, an ETF or mutual fund is preferable to investing directly in individual bonds.
“Fixed income securities don’t trade on an exchange so they’re over-the-counter and there’s not a lot of transparency around the pricing,” Wiley says. “Even if you negotiate a good price through an advisor, when you put it into the hands of a large asset manager, they’re going to have more pricing power because they are working all day, every day with the various counterparties.”
Other than price, access is a key consideration for investors choosing between ETFs and investing directly in the bond market. “If you think of traditionally building out a bond portfolio, having to buy the names individually, and bonds are sometimes hard to access as an individual,” Wiley says.