The passive wave arrives on fixed income securities

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Institutional investors are increasingly turning to bond index funds, including the increased adoption of exchange-traded funds following the Covid-19 pandemic.

A recent State Street survey of 358 global institutional investors – 82% of whom were from pension funds – concluded that passive investment in fixed income securities may be approaching an “inflection point.” In the survey, 66% of people around the world said they would prioritize using indexation for broad or liquid core fixed income exposures over the next three years.

“The reason you want more indexing allocation is for all the reasons indexing makes sense: liquidity, you can easily enter and exit markets and decide what exposures you want,” said Gaurav Mallik, Chief State Street Portfolio Strategist. Institutional investor.

Sixty-three percent of those surveyed said they would also use passive approaches to less liquid and non-core fixed income exposures over the next three years. Mallik attributed this trend to the liquidity benefits of indexing, as well as some general disappointment with the returns of managers active in more complex fixed income segments, such as high yield strategies and emerging market debt. .

In fact, 44% of investors surveyed said their institutions plan to increase their allocations to high yield index strategies, while 36% said the same about emerging market debt strategies. Respondents cited lower costs and improved efficiency, the desire to maximize the impact of asset allocation decisions, the increasing difficulty of adding alpha through active management and liquidity and transparency improved prices as the main drivers of increased indexation of fixed income securities.

For institutional investors looking for additional liquidity, ETFs seemed like an obvious option for low-cost, liquid exposure. The onset of the Covid-19 pandemic in March 2020 has placed many investors in a “liquidity crisis,” which Malik says has prompted investors to seek more transparent and liquid strategies.

According to the survey, 71% of investors have a “strong” or “very strong” appetite for increased use of ETFs for core fixed income strategies. For non-essential strategies, this figure was 48%.

James Clarke, managing director of credit firm Blue Owl Capital, said the survey results are largely in line with his institutional clients’ recent approach to fixed income. Specifically, Clark said he believes the percentage of core and non-indexing fixed income exposures will increase in the future. But, Clarke said he has noticed a trend over the past five to seven years in which more sophisticated institutions are shifting from passive asset classes and index exposure to more inefficient markets.

“Investors are leaving markets where the ability to generate excess returns is more difficult because you have so many participants and your returns are very much tied to market beta,” Clarke said. “And then they go to active and inefficient asset classes, like private assets, where you may not have the same capabilities, but also where there is less competition and where the opportunities for disproportionate returns are higher. ”

From Mallik’s perspective, institutions are looking for a healthy mix of indexing and active asset management: “At one point most people would say all assets were going to active managers and cavities like the high yield debt and emerging markets. Now, more and more investors are saying we want to get a mix between indexing and assets at all levels. ”

In general, institutional survey respondents expressed a lack of satisfaction with their entities’ current bond strategies: less than half of survey respondents said they were “somewhat satisfied” or “extremely satisfied” of the performance of their actively managed strategies, indicating a general appetite for change.


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