Fixed Income ETFs and the Corporate Bond Liquidity Challenge Greg Walker, CFA Managing Director, Head of ishares Business Development

Transcription

1 Fixed Income ETFs and the Corporate Bond Liquidity Challenge Greg Walker, CFA Managing Director, Head of ishares Business Development March 3, 2015 For professional clients / qualified investors only

2 Agenda 1. Bond Buyers Challenge 2. Application of Fixed Income ETFs For accredited investors in Canada only- Proprietary and Confidential 2

3 Bond Buyers Challenges

4 Percent of Index Constituents Recent Trends Illustrate Less Liquidity in the US Bond Market Primary dealers are holding less inventory on their balance sheets due to the impact of regulatory changes from Volcker Rule and Basel III. Liquidity has been reduced and bid-ask spreads have widened IG bid-ask spreads have widened 57% from 2007 New issues are 3.4x oversubscribed and only allocated to large fixed income managers Finding actionable bids and offers in volatile markets can be difficult, especially when less than one third of large corporate bonds trade daily Falling Bond Inventory at Broker Dealers Most Large Corporate Bonds Do Not Trade Daily Least liquid 40% 35% 30% 25% 20% 15% 10% 5% 0% Most liquid 38% 29% 23% 9% 2% Corp (Before 4/1/2013) CMBS High Yield Barclays Corp Index Market Value RMBS Commerical Paper Inv Grade Average # days bonds in the Markit iboxx $ Liquid Investment Grade Index traded each month Source: Federal Reserve Bank of New York, Barclays, as of 12/31/2014. BlackRock, Markit iboxx, Trace. Data from 1/1/ /31/2013 for the Markit iboxx $ Liquid Investment Grade Index ( investment grade ). There can be no assurance that an active trading market for shares of an ETF will develop or be maintained. For accredited investors in Canada only- Proprietary and Confidential 4

5 Fixed Income ETFs Offer an Alternative to Better Maintain Expected Yield Rather than trading in the over-the-counter (OTC) bond market, investors can access these exposures on an exchange which can lower the cost of trading and improve price transparency. Fixed Income ETFs are generally fully funded, unlevered vehicles that hold physical bonds Institutional investors primarily use fixed income ETFs as core long-term investment holdings, tools for targeting precision exposures, and as financial instruments that serve as substitutes or complements to derivative-based beta vehicles Bond ETF features Primary uses Exchange listed like a stock Core investments Fixed income ETFs Precision exposures Diversified like a portfolio of bonds Substitute or complement to derivatives For accredited investors in Canada only- Proprietary and Confidential 5

6 Underlying Bond Average Daily Volume ($ Billions) Average Daily Volume- ($ Millions) Fixed Income Liquidity During Stressed Markets During late 2008, when the credit markets became dislocated and illiquid, Investment Grade Corporate Bond ETFs rose significantly as investors began using ETFs for corporate bond exposure Corporate Bond and ETF Volume (Monthly) $25 $180 $160 $20 $15 $140 $120 $100 $10 $5 $80 $60 $40 $20 $0 1/08 2/08 3/08 4/08 5/08 6/08 7/08 8/08 9/08 10/08 11/08 12/08 1/09 2/09 3/09 4/09 5/09 6/09 7/09 $0 Corporate Bonds ADV Investment Grade Corporate Bond ETF ADV For illustrative purposes only. For accredited investors in Canada only- Proprietary and Confidential 6

7 Total AUM ($B) Growth of Fixed Income ETFs US Fixed Income ETF AUM is Over $270B Mortgage Leveraged/Inverse Aggregate High Yield IG Credit Bank Loans Inflation-Linked Government Govt/Credit Municipals Assets have climbed 380% since 2008 as investor adoption has increased and existing users have broadened their usage YTD 2014 Fixed income ETF usage has grown significantly, solving many challenges of trading in the OTC market Growth in fund size, breadth of bond market exposures, and liquidity have continued to drive increased adoption of ETFs A wide cross section of investors, such as endowments and foundations, asset managers, insurance companies, and pension funds are now pioneering new investment approaches using ETFs Source: BlackRock and Bloomberg as of 6/30/14. For accredited investors in Canada only- Proprietary and Confidential 7

8 The Majority of ETF Trading Occurs on the Exchange 16 Secondary to Primary Market Ratio Year Laddered Corporate Bond Index ETF Canadian Short Term Bond Index ETF /29/2014 2/28/2014 3/31/2014 4/30/2014 5/31/2014 6/30/2014 7/31/2014 8/31/2014 Sources: BlackRock and Bloomberg, as of September For illustrative purposes only. The performance quoted represents past performance and does not guarantee future results. For accredited investors in Canada only- Proprietary and Confidential 8

9 Bid/Offer Spread (bps) Fixed Income ETF Transaction Cost Savings ETFs generally offer price improvement, making the ETF less expensive to trade than the underlying securities of the respective index ETF ishares Bid/Offer Bid/Offer Basket Bid/Offer* (est.) Year Treasury Bond ETF iboxx $ High Yield Corporate Bond ETF iboxx $ Investment Grade Corporate Bond ETF 1-3 Year Treasury Bond ETF TIPS Bond ETF Core Total US Bond Market ETF JP Morgan USD Emerging Markets Bond ETF ADV($M)** AUM ($M) 3,731 13,746 17,816 7,931 13,192 17,643 5,191 *Market Bid/Offer spread refers to the underlying securities of the respective index **20-day average daily volume, as of 6/30/2014. For illustrative purposes only. Source: BlackRock, Bloomberg, Barclays, NYSE Arca, as of 6/30/2014. Assets in USD For accredited investors in Canada only- Proprietary and Confidential 9

10 Cost Effectiveness: Add another Layer of Cost Efficiency to Your Bond Trading ETFs can offer price improvement making the ETF less expensive to trade than the underlying securities of the respective index Basket Spread (bps) ETF Spread (bps) Canadian HYBrid Corporate Bond Index ETF Canadian Corporate Bond Index ETF 1-5 Year Laddered Corporate Bond Index ETF Core Canadian Short Term Corporate Maple Bond Index ETF Canadian Universe Bond Index ETF Canadian Short Term Bond Index ETF Canadian Government Bond Index ETF Average Daily Volume (30 Day) ($M) Assets Under Management ($M) 385 1,474 2, ,562 2, Source: Bloomberg, BlackRock as at 18 th September Assets in CAD This material may not be distributed beyond its intended audience. - Proprietary and Confidential 10

11 Application of Fixed Income ETFs

12 1) Core FI Allocation Client Challenge A Canadian based Discretionary PM needed to park a cash balance of around $40m for 4 months before allocating into equity ETF exposures. The PM selected 4 floating rates bonds they were comfortable as a temporary fixed income exposure. Then asked their bond desk to price the bonds in an equal weight. The client was unhappy with the bid offer cost quoted by the bond desk, especially given the holding time of only 6 months. Solution The client was able to trade the Floating Rate Index ETF with very similar exposure to the floating rate notes the client had selected. The client traded in and importantly out of the Floating Rate Index ETF paying in total a 2c bid offer spread (10bps). Source Bloomberg as at 30 th September Case study shown for illustrative purposes only. This is not meant as a guarantee of any future result or experience. This information should not be relied upon as research, investment advice or a recommendation regarding the ishares Funds or any security in particular. There can be no assurance that an active trading market for shares of an ETF will develop or be maintained. This material may not be distributed beyond its intended audience. - Proprietary and Confidential 12

13 2) Improve the Portfolio s Liquidity Profile Liquidity Sleeve Client Challenge A US insurance company with $3bn of credit bonds was looking to enhance the liquidity of their portfolio without sacrificing yield or credit quality. Cash bond liquidity has been impaired due to regulatory restrictions impacting broker dealer inventories The client s risk department had concerns about quickly liquidating their position in case of a market disruption Falling Bond Inventory at Broker Dealers ,000 3,500 3,000 2,500 2,000 1,500 1,000 Primary Dealer Corp. Positions (>1 Yr Maturity) (LHS) Market Value of the IG Corp Index (RHS) Solution The solution reduced turnover by moving the maximum number of bonds into $738mm of the iboxx $ Investment Grade Corporate Bond ETF The iboxx $ Investment Grade Corporate Bond ETF increased the liquidity profile of the portfolio as the fund trades over $420mm a day on exchange The number of line items was reduced by 75% from approximately 400 to 100 Source: Bloomberg as of 6/28/2013. Case study shown for illustrative purposes only. This is not meant as a guarantee of any future result or experience. This information should not be relied upon as research, investment advice or a recommendation regarding the ishares Funds or any security in particular. There can be no assurance that an active trading market for shares of an ETF will develop or be maintained. This material may not be distributed beyond its intended audience. - Proprietary and Confidential 13

14 3) Fixed Income Transition Trades Case Study - October 2014 Client Challenge An Asset Manager was looking to increase the overall liquidity, scalability and operational efficiency of their $23m fixed income portfolio allocation. The client expressed that the current Canadian cash bond market lacked the necessary liquidity, inventory and transparency needed to manage their portfolio in their desired way. The client selected 2 fixed income ETFs as a way to access their desired fixed income exposure: Canadian Universe Bond Index ETF $20m Canadian Short Term Bond Index ETF $3m The client was looking for an efficient and fast way to trade out of their existing 29 line items across both a rates and credit portfolio and into the Canadian Universe Bond Index ETF and the Canadian Short Term Bond Index ETF Solution The results determined that 28 of the 29 line items could be accepted as a creation trade into the Canadian Universe Bond Index ETF and the Canadian Corporate Bond Index ETF. The client was able to create the Canadian Universe Bond Index ETF and the Canadian Short Term Bond Index ETF via the in kind creation process, where the bonds were exchanged for both priced using the index price, in this case FTME TMX mid. Post trade analysis, utilizing current bids and offers for the same bonds at the time of the trade shows that the client avoided approximately 11 bps or $28,000 in spread costs by delivering in-kind (via an AD) the bonds into ETFs rather than selling them in the cash bond market. Case study shown for illustrative purposes only. This is not meant as a guarantee of any future result or experience. This information should not be relied upon as research, investment advice or a recommendation regarding the ishares Funds or any security in particular. This material may not be distributed beyond its intended audience. - Proprietary and Confidential 14

15 Disclaimer Information All information about U.S.-based ishares funds is intended for institutional investors in Canada only. Institutional investors must satisfy the eligibility criteria set forth in the Terms & Conditions. If you do not meet this eligibility criteria, do not access or use the institutional investor section of the BlackRock.com/ca website or the information concerning U.S.-based ishares funds provided herein. The U.S.-based ishares funds have not been nor will they be qualified for sale to the public under applicable Canadian securities laws and, accordingly, any purchase or sale of the U.S.-based ishares funds in Canada that occurs as part of a distribution, and any subsequent resale, must be made on a basis which is exempt from or not subject to the prospectus requirements of Canadian securities laws. You are advised to seek Canadian legal advice prior to any purchase or resale of U.S.-based ishares funds. ishares ETFs are managed by BlackRock Asset Management Canada Limited or its affiliates. Commissions, trailing commissions, management fees and expenses all may be associated with investing in ishares ETFs. Please read the relevant prospectus before investing. The funds are not guaranteed, their values change frequently and past performance may not be repeated. Tax, investment and all other decisions should be made, as appropriate, only with guidance from a qualified professional BlackRock Asset Management Canada Limited. All rights reserved. ishares, ALADDIN and BLACKROCK are registered trademarks of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. Used with permission. This material may not be distributed beyond its intended audience. - Proprietary and Confidential 15