It’s time to rethink fixed income with ETFs

The role of fixed income in multi-asset portfolios is evolving with the unprecedented levels of market volatility we have seen this year, and it is hard to think of a better time to rethink fixed income.

In today’s fixed income markets, investors face increasing pressure to deliver returns, generate yield and maintain diversification. To do so, we believe there is a need to move beyond the outdated ‘active first and only’ fixed income approach and consider indexing and fixed income ETFs.

The best way to understand just why ETFs are suitable is to consider how they can help address the main challenges in today’s bond markets. We see four big challenges.

1. Resilience through diversification

Firstly, the endless search for yield has reduced resilience.

As yield becomes increasingly scarce, investors are allocating to riskier asset classes. Corporates and emerging market debt – a sizeable amount rated high yield – make up 40% of fixed income allocations in multi-asset portfolios1.This increase in exposures exacerbates credit spread risk. Such allocations also reduce the diversification benefits of bond portfolios by giving them higher correlation to equity markets – in particular during market downturns.

Indexing and ETFs offer investors transparency and clarity on portfolio exposures and risks in fixed income because of their rules-based approach. Moreover, they serve as efficient building blocks that could bring resilience to investors’ fixed income allocation through diversification, in a cost-effective way that also saves time. After all, indexing can offer access to as many as 25,000 bonds with just one trade2.

_{1 Source: BlackRock Portfolio Analysis & Solutions (BPAS) Portfolio insights 2020 edition, January 2020.
2 Source: BlackRock, Bloomberg as at 30 September 2020.}

2. Help to protect portfolio from currency fluctuations

Another challenge is the impact of currency fluctuations on overall performance. Foreign exchange is the largest risk in multi-asset portfolios, after equity risk. iShares fixed income ETFs could help with this offering various currency hedged share classes across exposures including Sterling, dollar, euro, krona and Swiss francs.

3. Flexibility

The third challenge is investors’ discovery that their portfolios lack flexibility.

As market volatility soared in March 2020, many investors discovered their fixed income allocations lacked the liquidity, price discovery and flexibility they needed to derisk. Investors need nimble, liquid fixed income exposures that remain liquid even during volatility.

Through ETFs, investors can price whole sections of the market and make informed decisions in real time. Moreover, in March 2020, flagship iShares fixed income ETFs continued to track their indices tightly, offering liquidity and price discovery.

Figure: Secondary trading volumes in UCITS fixed income ETFs testify to strong liquidity

Source: BlackRock, Bloomberg as of 30 June 2020.

4. Sustainability

The final challenge is sustainability. Interest has been on the rise in recent years, 2019 saw a 13% increase in allocations to sustainable fixed income as more investors seek ways to navigate the bond market with a sustainable lens. Investors also want a transparent and scalable implementation approach.

Investors can use iShares sustainable fixed income ETFs to achieve similar risk-return characteristics to traditional exposures while improving their portfolios’ sustainability profile.

Fixed income ETFs: A greater role in today’s portfolios
To conclude, bond investors face challenges. Fixed income ETFs could help investors address these. As multi-asset investors rethink the role of fixed income in their portfolios and address today’s portfolio construction challenges, we see an even greater role for fixed income ETFs.

_{Risk Warnings
Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.}

_{Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.}

_{Changes in the rates of exchange between currencies may cause the value of investments to diminish or increase. Fluctuation may be particularly marked in the case of a higher volatility fund and the value of an investment may fall suddenly and substantially. Levels and basis of taxation may change from time to time.}

_{Regulatory Information}

_{This material is for distribution to Professional Clients (as defined by the Financial Conduct Authority or MiFID Rules) only and should not be relied upon by any other persons.}

_{Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel: + 44 (0)20 7743 3000. Registered in England and Wales No. 02020394. For your protection telephone calls are usually recorded. Please refer to the Financial Conduct Authority website for a list of authorised activities conducted by BlackRock.}

_{For investors in South Africa}

_{Please be advised that BlackRock Investment Management (UK) Limited is an authorised Financial Services provider with the South African Financial Services Board, FSP No. 43288.}

_{Any research in this document has been procured and may have been acted on by BlackRock for its own purpose. The results of such research are being made available only incidentally. The views expressed do not constitute investment or any other advice and are subject to change. They do not necessarily reflect the views of any company in the BlackRock Group or any part thereof and no assurances are made as to their accuracy.}

_{This document is for information purposes only and does not constitute an offer or invitation to anyone to invest in any BlackRock funds and has not been prepared in connection with any such offer.}

_{© 2021 BlackRock, Inc. All Rights reserved. BLACKROCK, BLACKROCK SOLUTIONS, iSHARES, BUILD ON BLACKROCK and SO WHAT DO I DO WITH MY MONEY are trademarks of BlackRock, Inc. or its subsidiaries in the United States and elsewhere. All other trademarks are those of their respective owners.}