The difficult trading environment in bond markets is fuelling the use of bond ETFs in institutional portfolios, according to a recent survey of 104 US-based institutional investors conducted by Greenwich Associates. The report found that longer execution times, higher execution costs and increasing difficulty sourcing bond securities and completing trades – especially large ones – have driven institutions to look beyond individual bonds to alternative vehicles that can provide required exposures.

Andrew McCollum, Managing Director at Greenwich Associates.

“Bond ETFs are emerging as an important alternative, and institutions are incorporating the funds into their process of rotating sector allocations, increasing or reducing risk levels and adjusting duration,” said Andrew McCollum, Managing Director at Greenwich Associates.

Of the institutions participating in the study, 68% have increased their use of ETFs over the past three years and over 30% are considering replacing individual bond positions with bond ETFs in the next year. Furthermore, one-third of institutions surveyed plan to increase their use of bond ETFs in the coming year. Of these, 30% expect to boost ETF usage by more than 10%.

The report also found that a larger proportion of firms are using ETFs to execute large value trades with 31% reporting executing trades of $50m or more through ETFs, compared to 19% in 2015.

Bond ETFs are also increasingly being considered as a viable alternative not only to individual bond positions but also to structured products – of those institutions who use bond derivatives to gain fixed income exposure, 88% say they are considering or have considered using bond ETFs as an alternative.

For those institutions who use ETFs as a means of fixed income exposure, liquidity and low trading costs were stated as the most compelling reasons to adopt the vehicle with 85% of respondents citing both as main reasons for investing in ETFs. According to Greenwich Associates, this is also reflected in the fact that ETF usage rates have climbed to their highest levels in sectors experiencing liquidity challenges, including high-yield and investment-grade corporate credit.

Beyond liquidity, institutions cite a range of additional ETF benefits, including ease of use, operational simplicity, quick access, and speed of execution. As a result, they are employing the funds in an expanding list of applications ranging from managing cash positions and rebalancing to transitioning among investment managers.

“As a result of these trends, institutional use of bond ETFs will remain on a strong growth trajectory in years to come,” concluded McCollum.