Investors could pull money out of fixed income entirely once interest rates start rising, Matthew Tucker from BlackRock said on Thursday.
Tucker, head of iShares US fixed income strategy at the world’s largest asset management company, said if the US raised interest rates further, investors would switch to high yield or investment grade corporate bonds instead of US treasury bonds, or they might rotate out of fixed income entirely.
“It’s possible you could see some of that reaction if interest rates started to rise,” Tucker told Morningstar. “It’s not a long-term ban on fixed income as an asset class, but this could be a technical driver of outflows for some time.”
Tucker referenced the “taper tantrum” scenario in 2013 as a similar example. In 2013 when the US central bank the Federal Reserve said they would be winding down quantitative easing – slowing down the purchase of bonds – interest rates moved up sharply, triggering investors to move out of fixed income ETFs and mutual funds.
The view is widely held that the Federal Reserve will be the next central bank to raise rates, with the Bank of England following close behind. When the US interest rate moves higher, it will be a slow gradual pace.
Investment Income is Hard to Find
Investors searching for yields do not currently have “a lot of alternatives”, said Brett Pybus, head of iShares EMEA fixed income product strategy.
Thanks to many European countries currently offering negative yields on their government bonds, Pybus sees a lot of demand going into European investment grade or high yield corporate bonds. He expects that the sector will continue to face volatility, thanks to market uncertainty.
“The UK referendum will cause more volatility for certain,” he said. “We will just need to get used to this tough environment. I don’t see this low yield environment or the need for income theme going away any time soon.”
The flows data certainly back up his statement. Both European corporate bond ETFs and European high yield bond ETFs saw the largest inflows in five years with €2 billion and €1.1 billion in March this year according to Morningstar Direct, driven by the European Central Bank’s asset-buying programme – the decision to boost the economy by buying European corporate bonds.
Pybus also advised investors to be more creative and open to different asset classes.
“Investors need to add more diversification to portfolios and start moving from investment grade corporates into high yield,” Pybus said.
Growth of Emerging Market Bonds in April
Both BlackRock strategists think the volume of emerging market inflows in April are an “interesting story”. In April, according to Morningstar Direct, global emerging market bond local currency ETFs saw the largest net inflows in five years with €740 million. Within the iShares fund house, emerging markets local government bond came fourth in the top list with €524 million inflows.
However, Tucker warned investors that there is still a lot of currency volatility in emerging market bonds in the future.
The Growth of Global Fixed Income ETFs
In the first quarter of 2016, global fixed income ETFs recorded a $43.8 billion of inflows – 62% of all investors inflows. This is an impressive record given the volatile market environment, according to both strategists.
As a wider range of investors become more aware of ways to utilise ETFs in their portfolio, ETFs are a cheaper option to gain access to fixed income efficiently. BlackRock said investors were also using ETFs to a “bridge to gap” when switching from one active manager to another without losing an asset allocation.
“A more diversified set of investors have a better understanding and a more positive stance towards ETFs than in the past. This is happening across asset classes and across geographies. However, the biggest challenge of the growth of ETFs is how to increase education and awareness,” said Tucker.
