Interest in fixed income exchange-traded products mounts

“Bonds are back” has been a major theme of 2023, but 2024 is likely to see further inflows into fixed-income exchange-traded products.

| 3 min read

Many investors have had an ‘underweight’ rating on bonds for some time, with the era of low interest rates keeping a generation of investors more interested in equities – particularly the technology stocks leading the digital revolution.

Central bank actions have now started to reduce the high levels of inflation that emerged following the Covid-19 pandemic. Slowing US and European economies and strong gains in stock markets at the end of 2023 have brought with them concerns about equity-market valuations – and are encouraging flows out of other asset classes into government bonds.

Last year was a year of transition for the global economy and financial markets

As extreme inflation was brought under control, investors’ attention shifted to slowing growth and the prospects for rate cuts. The resulting rollercoaster ride included a surge in bond yields, with the 10-year US Treasury yield briefly touching 5%.

After an inflation-driven sell-off over the last 24 months, bonds issued by sovereigns and corporates now have starting yields much higher than those seen over the last decade. These yields may offer a more attractive return profile relative to their equity counterparts as well as a downside cushion during any equity market weakness, something that has been absent in recent years.

Within exchange-traded products (ETFs), fixed-income products are likely to be the biggest focus for investors over the next year, as investors realise they may be ‘underweight’ in their portfolios compared to their equity exposure. Expansion and innovation in bond ETFs should continue to benefit the global-fixed income ETF industry.

From a starting point, index investing via ETFs enables investors to take positions rapidly and efficiently. Product providers have already started launching a new range of set maturity bond ETFs and will be expanding on this over 2024. Fixed income looks set to play a crucial role within multi-asset portfolios in 2024, as investors attempt to navigate a potential recession on the one hand and the risk of higher interest rates for longer on the other. High-quality corporates have been in vogue as refinancing for many companies is starting to be required, with higher interest rates expected on refinancing deals.

In 2023 to mid-December, allocations to fixed income ETFs saw inflows at a comparable level to equity ETF inflows – and it was an exceptional year for asset growth in government bond ETFs. Some of the US Treasury duration products have been in the top 20 of inflows across all global ETF products.

The shorter end of the Treasury curve – where the bond has a relative short time period to maturity – has been a big benefactor of inflows, but we are seeing the market shift to the medium to longer term lately – continuing to move into government bonds and extending durations. European ETF providers will be concentrating on their fixed income ETF launches in 2024 – including different maturity durations for UK gilts from some providers. We are now returning to the ‘old normal’ – where credit actually costs something – so it appears that bonds really are back.

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