The opportunity for bond ETFs now

With rising interest rates, high inflation and geopolitical uncertainty driving market volatility, bond investors are looking for ways to position portfolios. Many are turning to bond ETFs to navigate today’s choppy markets.

More than $40 billion moved into global bond ETFs in the first quarter of 2022 even as a generational rise in inflation and tighter monetary policy resulted in sharp price declines for many bond benchmarks.¹ For comparison, an estimated $150 billion moved out of global bond mutual funds over the same period.²

Investors are using bond ETFs for three main strategies:

1. Repositioning for rising rates and inflation. Bond ETFs are typically passively managed, meaning they seek to track the performance of specific segments of the bond market. This modularity empowers investors to easily implement both strategic allocations and tactical trade ideas. With uncertainty around rate hikes and inflation driving markets, flows show that investors have allocated to bond ETFs that target short maturities, floating rate securities, and TIPS, for example.

2. Harvesting tax losses. The Bloomberg US Aggregate Index — a broad measure of bond market returns — fell 9.5% during the first four months of 2022 — the worst start to a year in its history.³ Historically, though, returns have been positive on average following prior bond market drawdowns.

Additionally, 97% of mutual funds in the Morningstar Intermediate Core-Plus Bond category now have a negative three-year price return, suggesting that many investors may have losses in their bond portfolios.⁴ A common strategy is to “harvest” these losses for tax purposes and reallocate to ETFs to maintain market exposure. Of course, it is important to observe the wash sale rule when doing so.

3. Capturing higher yields while managing costs. This year’s selloff has increased the yields on most bond categories. For example, treasury bond yields have risen from 1.2% to 2.9% YTD, and the yield of high yield corporate bonds reached 7% for the first time since 2020.⁵ Bond ETFs tend to have low management fees, no loads and low transaction costs. These savings help contribute to investors keeping more of what they earn.

The current environment is unique and challenging, but the fact that investors are turning to bond ETFs does underscore why the industry is growing even faster than we expected. The transparency of ETFs allows investors to better understand the risks they are taking — a key element for building portfolios in any environment, but especially one marked by high volatility and uncertainty. iShares offers over 100 bond ETFs across core, credit, floating rate, ESG and term maturity strategies. This wide range of tools can help investors build more resilient portfolios as they pursue their goals.

It took 17 years for global bond ETF assets to reach $1 trillion. In 2019, as the industry approached this milestone, we forecasted that the market would double by the end of 2024.⁶ In our new paper, Bond ETFs Turn 20: All Systems Go for $5 trillion, we upgrade our outlook and project that assets in bond ETFs will reach $2 trillion in 2023 — 18 months early — and grow to $5 trillion by the end of 2030. If anything, we believe the challenges associated with high inflation and rising interest rates will attract more first-time ETF investors and prompt existing investors to find new ways to use these versatile investment tools.