GIVING CREDIT WHERE CREDIT IS DUE

Giving credit where credit is due
As July sees record monthly flows in fixed income, fund flows into credit ETFs in particular have been gaining momentum, even as credit spreads continue to tighten on the back of a (still) resilient-than-expected economy. We see investors looking to credit ETFs for their liquidity benefits in navigating episodes of market volatility, as can be seen through average daily volume (ADV) and % share of largest credit ETFs traded. (left table)

The right chart shows, on a relative basis, that high quality fixed income (green) continues to attract more flows this year as investors turn more constructive in putting on quality duration trades and positioning for Fed rate cuts. That said, high yield (pink) did see +USD$3B inflows, predominantly in US Broad HY (as mentioned in pg2). The AUM of the top 2 largest US HY ETFs have both increased over the past year, yet the AUM gap has significantly narrowed – signifying how investors are broadening out their use cases when allocating to US HY.

What may (not) surprise most is that tighter credit spreads may not mean limited room for returns. Historically, deeply negative 12m returns from a position of tight spreads can be attributed to mainly two key market events: 2008 GFC and COVID-19 crisis. In both cases, there were sharp duration sell-offs on top of credit spreads widening.

Year-to-date for 2024, spread assets have largely performed (marked in yellow) while returns in duration assets were broadly marginal.

Decade-high levels of all-in yields are expected to drive bond returns through rest of the year. The ability to stay nimble by picking points on the yield curve, i.e. at the intermediate portion, could balance both credit and duration risk, while optimizing for potential price appreciation, liquidity and current yields.

No Time to Yield
A case for putting cash to work with bond ETFs

Last year, our whitepaper “The Great Yield Reset” discussed the generational opportunity for investors to rethink their portfolios with a greater focus on fixed income.

In our latest paper “No Time to Yield”, we highlight our updated expectation that global bond ETFs will reach US$6 trillion in AUM by 2030. We discuss the opportunity within bonds and why investors may want to consider moving now to capture decades high yields, get cash off the sidelines, and employ efficient, precise tools such as bond ETFs in this new market regime.

As investors take a more dynamic approach to asset allocation, we believe bond ETFs are among the most powerful tools within the investor tool kit to navigate this market environment.

The timing of potential interest rate cuts may be uneven worldwide, but the message is clear: Don’t wait.

Source: BlackRock, “No Time to Yield”, as of April 2024. There is no guarantee that any forecasts made will come to pass.

Key themes we discuss in this piece:

1. Time to put cash to work and capture higher rates: Yields are higher today than they have been in years. If inflation indicators continue to fall, the time of elevated cash rates may be drawing to a close.
2. Investors are choosing bond ETFs in record numbers, but they have room to do more: Many investors are still significantly underweight to fixed income, with a 22% average allocation, based on total global industry AUM, far below the “60/40” portfolio allocation often referenced in balanced portfolio discussions.
3. Now is the time to move: Even with ongoing volatility in economic data and bond markets, we believe it’s time for investors to move because, historically, the market has tended to price in rate actions before they occur.

Index Your Bonds with Asia Credit
Asia bond markets definitely have a part to play in the next leg of growth in index and ETF adoption. As investors continue to move beyond the “active versus passive” debate, constant product innovation will offer increasingly precise sources of potential returns, and help lead more investors to embrace bond index building blocks alongside high conviction active strategies in pursuit of optimal portfolio outcomes.

In this Asia-focused “Index Your Bonds” paper, we spotlight iShares Asia Credit exposures, provide insights on how they are managed in practice, and discuss how innovations such as ESG integration will make indexing an integral part of investing in Asia fixed income.