Fixed-Income ETFs Bolster U.S. ETF Market

 |  Includes: BND, BOND, SHY
by: Tom Lydon

Fixed income exchange traded funds have become the central focus of many investors, as equity markets remain volatile and big name providers are offering new products tracking this market segment. PIMCO has been given credit for bringing this market sector to the mainstream with the launch and success of the PIMCO Total Return ETF (NYSEARCA:BOND).

The ETF market has been able to maintain positive momentum in spite of the deepening sovereign debt crisis in the Eurozone and growing concerns about its impact on global economic activity. The fixed income ETF market has been experiencing global inflows of $85.3 billion in 2012, up 148% since the same time last year, reports Chris Flood for Financial Times.

Money poured into fixed income ETFs last month as inflows totaled $7.5 billion in U.S. bond funds.

Don Suskind, head of global ETF product management at PIMCO, said some clients prefer to use ETFs for fixed-income investments because they offer all the benefits of trading in the equities market-intraday liquidity, efficient price discovery, and access through an exchange. All of this is in a transparent portfolio, reports James Armstrong for Trader's Magazine.

"If they have any questions about what's in the portfolio, they can go online and download it," Suskind said. "You can see exactly what's in the portfolio."

There are some pitfalls with the fixed income ETF market. For instance, the underlying assets are less liquid in the bond market, versus the ETF equity market. PIMCO is often willing to take cash creations or redemptions of its funds, rather than ETF holders having to go through an authorized participant to help them cash in shares or get new ones issued.

Also, fixed income ETFs are not fully self-replicating like an equity ETF. Bond indexes often have thousands of issues in them, so in tracking an index, an ETF might only hold half the number of issues in the index, sometimes as few as 3%.

These minor drawbacks have not stopped investors from parking capital in bond ETFs for the time being. The fixed income ETF market has become a safety net in this current market as investors seek havens to stash their cash.

As the S&P 500 fell 6.3% in May, the Vanguard Total Bond Market Fund (NYSEARCA:BND) gathered $1.23 billion in new assets. The iShares Barclays 1-3 Year Treasury Bond Fund (NYSEARCA:SHY) took in $1.15 billion in assets. Those two funds alone accounted for about a third of May's $7.46 billion in total flows into U.S. Bond ETFs, reports Chris Gay for US News.

Vanguard Total Bond Market Fund

Click to enlarge

Tisha Guerrero contributed to this article.

Disclosure: I am long SHY.

Additional disclosure: Tom Lydon's clients own SHY.