Throughout autumn, the US Fixed Income ETF market (FI ETF) continued to grow steadily, as it had all year, with a few surprising twists. This parallels growth in the fixed income market in general, although the haunting feeling that change is right around the corner keeps bubbling up.
Growth and Concentration
By Nov. 1, 2019, the total FI ETF assets under management (AUM) had grown to within shouting distance of $800 billion, at $794,930,936,921. That represents growth of 15.38% year to date, and 1.87% growth just for the month of October. That monthly growth equates to an annual rate of more than 22%.
All of that growth can be accounted for by the introduction of new exchange-traded funds (and other exchange-traded products): The number of entries in the etfdb.com FI ETF database grew by 18, or 4.6% from the end of August 2019 to the end of October, while the average fund size actually dropped by 0.4% during the same two-month period.
That data would lead us to think that concentration has dropped somewhat, and the rest of the data supports that – sort of. The top five funds by AUM represented 25.1% of the total market on Nov. 1, as opposed to 25.57% at the end of August, and the top 10 held 38.5% of the total, down from 39.4% in August. However, when we look at the data by manager as opposed to by fund, we see that the concentration is very slightly higher. The top two managers control 73% of the AUM, and the top three control 82%, as opposed to 72% and 81%, respectively, in August.
Fund Share Trading Volumes
Next, we need to look at trading volume. We normalized this value by multiplying share volume by share price to get what we call “dollar average daily volume,” or $ADV. We then multiplied that number by 252 (the number of trading days in a year) and divided by the AUM to get a proxy for annual turnover. The top three and seven of the top 10 ETFs by $ADV were in the BlackRock family, giving support to the idea that ETF customers are moving between funds within a fund family to manage their exposure to segments of the fixed income markets. We will see more evidence of this when we cover fund flows a little later.
The average annual turnover for the top 10 FI ETFs by $ADV was 10.4, slightly lower than the 11.1 average for that group at the end of August. For all FI ETFs, the average annual turnover was 3.8 times, only slightly lower than the annual turnover figure of 4.1 times for the bond market as a whole in 2019. The top 10 ETFs by AUM had an average annual turnover of 2.5, and the top 20 had a turnover of 2.9. Finally, 30 of our universe of 409 FI ETFs, representing $1.3 billion in AUM, had no trading activity at all for 2019.
It is important to distinguish fund trading volume from fund flows. An ETF can have quite high $ADV over relatively extended periods without generating appreciable flows, as long as the daily trading activity is essentially balanced. It is only multi-day order imbalances that prompt authorized participants to create or redeem shares in any size. Given the very low volatility of interest rates, it shouldn’t surprise us if fund flows were much smaller than $ADVs.
It is the fund flows (FF), though, that really tell us where the money is going, and start to give us some idea of why. For the top 10 in YTD FF, the average was 32% of the starting AUM, and for the bottom 10 it was -18%. Six of the top 10 YTD FF winners were BlackRock funds (totaling almost $18 billion), as were four of the top 10 losers (totaling $8 billion) – a further indication of trading between funds within the same manager. On the losing side, the bottom four funds are all short- to intermediate-term funds, perhaps indicating a general belief that rates won’t rise in the near future.
The overall movement between funds, and the selection of FI ETFs, does not appear to be significantly driven by returns, if at all. The average YTD return for the top 10 funds in FF was 9.62%, comfortably above the average of 6.31% for all 409 FI ETFs, but only slightly above the 7.33% average for the bottom 10. In fact, three of the bottom 10 in YTD FF had YTD returns of more than 10%. More and more it appears to us that people are opting in and out of these funds based on their interest rate projections, not based on fund performance or even fees. So far this year, large size has not been a deterrent to performance, with the weighted average return for the top 10 by size comfortably above the 6.31% average at 8.81%.
We looked at a lot of data, but what did we conclude from it?
- The growth of FI ETFs continues apace.
- Concentration, at both the fund and manager levels, does not appear to be volatile at all.
- Trading and fund flow data indicate that customers tend to stay within a fund family when they shift strategies.
- The same trading and fund flow data indicate that customers tend to trade ETFs based on their market projections instead of past performance.
- For all market participants, the indexed nature of most FI ETFs allows diversification at low or no cost.
- The large daily trading in ETFs has begun to impact the market in the underlying bonds.
- The growth of passive FI investing, much of it through ETFs, has cast a spotlight on the functioning of the credit rating agencies.
Will this market continue to grow, in both AUM and $ADV, for the foreseeable future? Will the concentration structure remain relatively unchanged for the foreseeable future? Will the FI ETF market become the FI trading market of the future? Stay tuned.