'Evolution To Be Faster And More Disruptive': Bond ETF AUM To Double To $1.5trn By 2022

Heather Brownlie, head of US fixed income at iShares, said the main drivers for the increase in flows was already underway as a result of increased transparency, modernisation of trading through clearing and electronic platforms and the adoption of standardised instruments such as rules-based derivatives.

"While fixed income markets were already beginning to evolve prior to 2008, the fallout from the crisis has catalysed a behavioural shift in the market," said Brownlie.

Although fixed income ETFs were evolving much in the same way as equity ETFs, Brownlie said the structural features of the asset class, such as "heterogeneity and fragmentation", meant a different approach was required.

Will bond ETFs be genuine market disruptors?

"The structural features of bond markets do not naturally lend themselves to a pure equity market infrastructure," Brownlie said.

"As a result, a more complex approach and more robust set of tools will be necessary to address the longstanding challenges of the bond market.

"We believe that those who embrace and adapt to the coming changes have the greatest potential to benefit."

These changes, Brett Pybus, head of EMEA fixed income strategy at iShares, said would include future ETF vehicles becoming "more refined and granular" with a move from broad to sub-indices.

Pybus said: "This will allow investors to access fixed income exposures that are highly targeted by sector, industry, size, quality or a number of other factors or characteristics.

"We believe that index/basket exposure vehicles will serve as building blocks and play an increasing role in how investors construct fixed income portfolios.

"This evolution is likely to be faster and more disruptive than many market participants currently expect."

Market outlook

Bond ETF AUM stands at $750bn with flows into totalling $38.7bn in Q3, mainly driven by investment grade corporates which recorded the most inflows of $9.4bn while Treasuries and multi-sector fixed income posted inflows of $7bn and $5.8bn respectively.

Despite the strong flows into US Treasuries, Brownlie said it was important for investors to protect their portfolios in the rising rate environment in the US.

"The brief August sell-off driven by macro risk concerns around North Korea were a helpful reminder for some investors to pay attention to rates exposure in their portfolios."

"Inflation in the US will be key to the policy and market outlook," Brownlie said. "We prefer treasury inflation protected securities (TIPS) over nominal treasuries given the challenges a sustained economic expansion pose for treasuries, and valuations look more favourable amid weaker inflation prints."