In the 15 years since the launch of the first bond exchange-traded fund, assets under management of fixed-income ETFs in the United States. have grown from virtually zero to $537 billion as of March 16, 2016, according to Morningstar data. This rapid growth speaks to the wide range of applications investors have found for bond ETFs. This article explores a few notable use cases, and it will also show that performance is not always the most critical factor that investors consider when selecting fixed-income ETFs. Regardless of how investors use bond ETFs, growth in adoption should benefit all who use these funds. As the size of these funds’ assets and investor bases grow, liquidity improves and transaction costs decline. This growth also enables ETF providers to achieve economies of scale and in some cases to share the benefits of their greater heft with investors in the form of lower fees.
The explosive growth of fixed-income ETF assets is attributable to a number of structural changes in the capital markets. Specifically, investors are increasingly using fixed-income ETFs as a source of liquidity because post-crisis regulations have reduced liquidity in the U.S. bond market. Also, bond ETFs are replacing some derivatives traditionally used for fixed-income exposure. Finally, insurance companies are starting to embrace bond ETFs thanks to a recent regulatory change that allows them to hold credit ETFs without meeting onerous capital requirements.
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Phillip Yoo does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.