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Why Bond ETFs Are Gaining Traction

In the first nine months of 2015, investors added $7.7 billion to investment-grade corporate bond ETFs. While we think demand for high-quality fixed-income securities is strong, in light of modest Treasury yields, while in our view inflows have also been aided by actions banks have taken to reduce inventories of bonds Available for Sale.

According to a recent article published by SNL Financial titled “Relative size of bond portfolios shrinking on bank balance sheets”, banks have increasingly placed their holdings of bonds into their held-to-maturity (HTM) portfolios.

HTM portfolios are not subject to mark-to market adjustments on a quarterly basis and as such do not impact a bank’s capital levels the same way bonds available for sale, an important consideration as Basel III capital rules phase in.

As such, individual bonds trade with less liquidity than investors may realize. According to iShares, less than one third of the bonds in the Markit iBoxx Liquid Investment Grade index traded on a daily basis during 2014.

At the same time that bonds are trading less regularly, U.S. corporations have frequently tapped the credit markets while interest rates remain low. According to S&P Capital IQ Leveraged Commentary & Data, the $919 billion of investment-grade issuance in the first nine months of 2015 was 23% higher than a year earlier and was approaching the full 2014 issuance totals of $979 billion. 

In that context, we think for investors that want daily access to investment-grade corporate bonds, ETFs have been and in our view can continue to be a solution. iShares iBoxx Investment Grade Corporate Bond ETF (LQD), a $22 billion ETF, trades intra-day more than 3 million shares. According to MarketScope Advisor, 20 taxable fixed income ETFs trade more than 500,000 shares on a daily basis. The most actively traded ETFs are SPDR Barclays High Yield (JNK) and iShares 20+Year Treasury Bond (TLT), each providing investors with different risk/reward attributes.

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