INVESTING

Bond ETFs are feeling the flow

Chris Dieterich |Jul 29, 2019

Now at $1 trillion, bond ETFs are a blockbuster innovation that offer potential benefits to all investors

It was a suburban teenage conundrum. I’d bike to Blockbuster Video only to find the much-coveted new releases out of stock. What to do? Unwilling to gamble (remember late fees?), and unschooled in the virtues of less-picked-over classic and cult films, I often resorted to the tried and true: “Happy Gilmore” or “Tommy Boy.”

Then, almost overnight, renting movies was transformed. Netflix boasted access to what seemed like an infinite catalog, with the convenience of DVDs delivered straight to our doorstep. A hive mind of subscriber reviews, combined with high-tech recommendation algorithms, helped users discover new titles. Years later, on-demand streaming cut rental times to mere seconds from days or weeks.

The evolution in how we rent movies parallels how exchange traded funds (ETFs) made it simple and efficient to access to global bond markets. As with many innovations, bond ETFs—which iShares pioneered months before the Netflix initial public offering in 2002—streamlined what was previously a cumbersome process.[1] Bond ETFs simplified and expanded the selection available to ordinary investors, providing new options to reach for goals such as income and portfolio diversification.

Leaving a mark on global markets

Bond ETFs make it as easy to buy and sell bundles of bonds as it is for stocks. While this sounds simple, the innovation represents a giant leap forward from previous eras, when finding and pricing individual bonds—particularly corporate and emerging-market issues—was often opaque.

The first ETFs were linked to Treasury bonds and high-grade corporate debt. Today there are nearly 400 bond ETFs listed in the U.S. and more than 1,300 across the globe.[2] In June 2019, global assets eclipsed $1 trillion for the first time. A big number, to be sure, but bond ETFs remain a fraction of the $105 trillion global fixed income marketplace.[3]

Wider adoption has translated into heavier trading volumes, which generally result in lower on-exchange transaction costs. Convenience and ease of trading help explain why investors increasingly rely on bond ETFs to reposition their holdings during periods of market turbulence, such as the final months of 2018.

An eye toward the future of portfolios

Bond ETFs are also helping dispel the false narrative that passive and active investing are mutually exclusive. All types of investors are recognizing that modern portfolios combine active management and index-tracking products. Some investors use broad bond ETFs to diversify their stock holdings; others use term-maturity bond ETFs to help generate predictable income through laddering; and still others use bond ETFs alongside individual securities in their portfolios.

Recent market trends underscore that bond ETFs are tools for building dynamic portfolios. U.S.-listed bond ETFs pulled in $37.4 billion in the second quarter of 2019, the most of any quarter on record.[4] These days, many investors are actively targeting bond ETFs to search for yield as global central banks consider whether to loosen monetary policies in the near future.

See our guide to investing in the second half of 2019.

Looking ahead, we think that investors will continue to find novel uses for these versatile tools. Additionally, powerful advances in technology, market

structure and product innovation will help lead more investors to bond ETFs for the first time. Taken together, we believe that global bond ETF assets could double over the next five years, to $2 trillion, to the benefit of all investors.

Related iShares Funds

  • iShares iBoxx USD Investment Grade Corporate Bond ETF (LQD)
  • iShares 1-3 Year Treasury Bond ETF (SHY)
  • iShares 7-10 Year Treasury Bond ETF (IEF)
  • iShares 20+ Year Treasury Bond ETF (TLT)
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