The European bond market is modernizing at a rapid pace – and fixed income exchange-traded funds (ETFs) have become the vehicle of choice for this modernization. This reflects their increasing liquidity, transparency and versatility.
Over the past five years, the European corporate bond market has grown 56% to € 2.8 billion (£ 2.4 billion) of outstanding debt [Source: Bloomberg Barclays, as at 30 June 2020].
Increasingly, trading is done electronically. One of the drivers is the European MiFID II Directive, which came into effect in 2018, moving trading to regulated venues and imposing new obligations on regulatory business reporting, business transparency and best execution. All of this is much easier to do through electronic marketplaces.
Fixed income ETFs have also experienced rapid growth. The $ 334 billion (£ 243.5 billion) European UCITS ETF market has shown a compound annual growth rate of 22% over the past five years [Source: BlackRock, as at 31 January 2021].
The Covid-19 crisis has been a big test of the liquidity of European bond ETFs for institutional investors. During the volatile financial markets of March 2020, ETFs proved their resilience, trading efficiently and offering liquidity, flexibility and price transparency. They continued to follow their benchmarks closely.
Bond UCITS ETFs traded an average of $ 5.3 billion per day in March, nearly double the daily average for 2019 [Source: BlackRock, Bloomberg, as at 30 June 2020]. Additionally, as secondary fixed income ETF trading volumes plummeted in the months that followed, individual ETFs continued to set new records.
As the ETF market grows, so does its ecosystem. We see this in practice through the growth of the loan and option markets.
In recent years, fixed income ETF lending has increased. The stock of EMEA-listed bond ETFs available for borrowing has grown by over 60% over the past three years, reaching $ 14 billion in June 2020. Loan balances have more than quadrupled [Source: IHS Markit, as at 30 June 2020].
The continued adoption of bond ETFs and other bond index tools, the growth of electronic trading, algorithmic pricing capabilities and dramatic technological improvements are revolutionizing the way investors access European bond markets. The recent sale of Covid-19 has proven to be a catalyst for the further adoption of bond ETFs, especially by institutional investors.
Investors are increasingly managing their exposure to fixed income through a portfolio lens, using a broader toolbox to access European corporate debt. The largest and most liquid ETFs are emerging as the macro and scalable risk transfer tools of choice for investors. ETFs also offer a standardized index-based tool that enables ESG integration. Market transparency should continue to improve and positively fuel the liquidity of the underlying bond markets.
This change benefits investors. However, given the still opaque nature of the underlying spot bond market, coupled with the lack of a unified and timely picture of bond transactions and prices (a consolidated band), we believe ETFs play a role. essential for investors who wish to gain exposure to corporate bonds denominated in euros, whether good quality or high yield.
Looking ahead, another key driver of growth will come from the increasing transition of investors to sustainable investing. As this shift gathers momentum, we expect sustainable fixed income ETFs to become flagship funds for investors.
Natacha Blackman is a bond product strategist at iShares EMEA
The fluctuation can be particularly marked in the case of a fund with higher volatility and the value of an investment can fall sharply and substantially. Levels and the tax base may change from time to time.
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