Exploring Two Decades of Fixed Income Innovation

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  • 07 mins 46 secs
Take a closer look at the latest SPIVA results as S&P DJI’s Brian Luke and BlackRock’s Stephen Laipply discuss how indexing works for fixed income, the iBoxx liquidity ecosystem, and what a growing range of passive tools could mean for yield seekers as income returns to fixed income.
Channel: S&P Dow Jones Indices

Speaker 0: Set a record, we took in over 200 billion as an industry last year. And we've also seen strong flows so far this year,

Speaker 1: I think you see all the flows coming out of mutual funds and yet into bond etfs. And this speaks to the passive investing approach that's predominant in those products. And I think that really speaks volumes when you're looking at mutual funds going out and etfs going in it tells you the real story.

Speaker 0: I think it's a couple of things. Number one, as Brian said, it's a long term trend towards towards the value of indexing, right? Understanding that you can have robust portfolio construction that there is predictability that there's transparency. Some part of this was probably some tax loss given that it was the worst bond market in at least 40 years. So investors actually took the opportunity that was given to them to retool their portfolio. So you can imagine

Speaker 0: some investors may have been holding the same fund or strategy for many years. The market changed, that gave them the opportunity to retool entirely and they did it and they used bond etfs to do it because they're efficient and it's a quick way to retool

Speaker 1: historically, you see a lot of the mutual funds being active and a lot of the fixed income etfs being passive or index replicating. So I think it's a changing of the guard. I see a lot of the investors are getting used to indexing works. They see indexing working in equities, they see indexing working now on fixed income. So it's really been helping drive the.

Speaker 1: So when you look at some of the speed of research that we've done, and we've embedded a lot of the IBO Liquid investment grade and I Boxx liquid high yield indices into our speed of research. This research goes back 10 to 15 years as long as these products have been around. So a lot of the investment grade performance, 90% of the investment grade managers can't beat the benchmark on a five and 10 year basis. You see a little bit more of a coin flip, coin flip in the last couple of years in the short term

Speaker 1: yield, it's a little bit more favorable for active. But I think that also speaks to how active and passive use the index based tools to access the portfolio. And I think we saw that through the growth in volumes during the COVID sell off, we saw over 200% increase in volumes in index replicated funds as opposed to just the cash market, only a 50% increase. So a lot of people are accessing it, whether it's passive or active.

Speaker 0: Yeah, I would agree. I think the,

Speaker 0: what we're finding is the whole active versus passive thing is a bit of a dated argument. What we tend to experience is for the investor using both in a combined way. So they'll have an active manager who is tasked with generating excess return. But they know even in high yield, they want a predictable transparent index exposure because they want to know the risks that they're taking.

Speaker 0: And to add to the point about active managers, we've seen a huge uptake in active fixed income managers to Brian's point using Bon etfs as active tools. So whether that means quickly scaling in and out because of an opportunity in the market managing liquidity or even something as simple as having better operational risk because it's a simpler bundle vehicle.

Speaker 1: I think at the end of the day,

Speaker 1: when you look at fixed income, you're looking at interest rate management, you're looking at credit risk management, but there's a third element now that's liquidity management. So the IBO Liquid ecosystem helps perpetuate that in the form. But also in the derivatives form, we see tremendous growth, record, record growth in the volumes and derivatives tracking I Boxx Liquid

Speaker 0: Ecosystem Index tools that an entire ecosystem is sprung up around those products.

Speaker 0: So in credit, those products are central to both the high yield market and the investment grade market. They have ancillary exposures around them options, futures, total return swaps. So an entire ecosystem has been built up. What that means simply is investors have a lot more tools to choose from.

Speaker 1: So what we saw during that COVID sell off, we saw a tremendous amount of corporations taking advantage of low rates. And then when rates rose last year, they all kind of backed off. What that did to the IBO indices was you see a lengthening of interest rate risk or duration and that lengthening was

Speaker 1: inopportune during the time when rates are rising. Now, the duration, the risk profile of the investment grade index has come back down to what its 10 year long run average has been a little north of eight years in duration. So that supply demand balance is kind of taking place in the indices that we track.

Speaker 0: I think as Brian said, I mean, we are reaching probably somewhat of a stabilization in rates now that can be favorable for credit spreads. And I want to caveat this unless someone truly believes a recession is on the horizon. So that's what's being debated in the market right now is what does that recession look like?

Speaker 0: What does that recession risk look like? How much of it is actually priced in? Do investors feel that they're getting fairly compensated right now? I

Speaker 1: mean, if you're going to be seeing the yields of 5% in IBO investment grade and north of 7% in IBO high yield there is credit risk inherent in that yield. When we look at the S and P global ratings default measures, it was around 1.6% towards the end of last year. That's half of what it was before the COVID

Speaker 1: sell off. And if we return to that normal level, then there's going to be some which speaks to some need for diversification in that market.

Speaker 0: I think it's very bright for the first time in many years, investors are able to actually generate income in their portfolio. And so I do think what we saw in terms of flow patterns, speaks to that investors were under invested

Speaker 0: in fixed income for many years because the absolute low level rates, they had to take more risk to get the same yield level. This has changed everything. The great rep price is allowed investors to come back into fixed income and do so in a thoughtful way, they've had a chance to completely retool their portfolio. So I think it's a good

Speaker 1: thing. I think about

Speaker 1: 500 the dividend yield offer right now, that's under 2%. Now you can get that and more in Corporates, you can get that and more in high yield. And these are levels that, you know, Steve you haven't seen in 10 years of the growth of these products. And now we're seeing levels that are truly attractive, putting the income back in and

Speaker 1: and it's not just a credit risk story, right, the spreads on top of the treasuries in the IBO indices are relatively fair value over the last 10 years. They're not at their widest level that you would see at like a credit crisis type event. But the

Speaker 0: front end of the treasury curve, you can get close to 4.5%. We have not seen that in a long time.

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