Bond ETFs are popular among investors because of their resilience, liquidity and efficiency. What can investors expect from the asset class now? A conversation with Matthias Wang, Fixed Income Index Product Strategist at BlackRock and Sebastian Meyer, S&P Dow Jones Index Fixed Income Product Management.
Matthias Wang: In our opinion, this can be described as the end of the “great moderation”. We have entered a new market regime characterized by greater macroeconomic and market volatility and persistent inflation. Looking ahead, the yield on 5-year German government bonds has so far risen to around 2 percent. High quality euro investment grade bonds are now yielding around 4%. We haven’t experienced either in over ten years. And both speak to the opportunities that bond investors will have going forward.
What does the new environment mean for interest rate ETFs?
Wang: Bond ETFs have been tested in a number of worst-case scenarios and proven to provide price discovery and liquidity in volatile markets. It helps investors evaluate bond ETFs for their resilience, liquidity and efficiency. It is also an advantage to be able to quickly trade bond portfolios with them. So we are at an inflection point for bond ETFs. As we are going through a phase of realignment in asset allocation, with a particular focus on investment grade bonds.
Mr. Meyer, how do index providers deal with re-risking in the new market environment?
Sebastian Meyer: The focus of the new indices is clearly on the short term. These include fixed rate bonds up to five years and floating bonds. We see interest in such indices across all major currencies such as EUR, USD and GBP. This is not surprising as interest rate normalization has affected bond markets around the world.
What are the possibilities of investing in indices, also in combination with active investments?
Mayer: We are seeing interest in ESG, climate-focused indices and other thematic indices. Here I would name for example iBoxx MSCI ESG USD Asia ex-Japan High Yield Capped TCA and iBoxx MSCI EUR High Yield Paris Aligned Capped Index.
Wang: We start BlackRock’s multi-asset strategies, which are a mix of active and indexed investments, with a 50% index position. In fact, our research shows that there are several key reasons why investors consider index strategies. First, up to 90 percent of asset class returns can be achieved through indexation. We also find that investors need to adjust their strategic allocations more frequently in response to macroeconomic volatility. Bond ETFs are an important tool for trading flexibility.
How should efficient, future-proof index structures be structured now?
Mayer: When it comes to index compilation and methodology, we place great emphasis on liquidity, transparency and, finally, simple and clearly understood rules. Before creating a new index, we create various simulations. We look at historical performance and reduce transaction costs. The index is then created and published.
Mr. Wang, what is the role of inflation-linked bonds and corporate bonds in the new phase of the market?
Wang: Investors now have more opportunities than ever to gain exposure to different types of bonds across currencies, maturities, regions and sectors through indexed strategies. When we ask what role these bonds play, we think about strategic and long-term and tactical positioning. When it comes to government bonds, the BlackRock Investment Institute favors inflation-linked bonds, particularly European bonds. In corporate bonds, investment grade bonds can be an interesting value for investors. We believe valuations are attractive given the total return and yield differential relative to government bonds. Coupon yields are at their highest in about a decade.
Over the past few decades, the use of information providers has grown and transformed asset management. Critics say index providers inflate asset valuations and inflate investor demand. Is this a concern?
Mayer: Most of our indices are market-weighted. This means that they represent the real market and are therefore inherently…