- Yields are higher today than they were 20 years ago. If inflation indicators continue to fall, the time of elevated cash rates may be drawing to a close.
- Investors are choosing bonds in record numbers, with 2023 global bond ETF inflows at $333 billion.
- But investors are still significantly underweight to fixed income, with a 22% average allocation, based on global industry assets under management.
- We believe investors may still want to consider moving back into fixed income because, historically, the market has tended to price in rate actions before they occur.
- ETFs can be a powerful tool for investors as they recalibrate their fixed income allocations.
KEY POINTS
INTRODUCTION
Interest rates are now at their highest levels since the early 2000s, helping to make bonds more attractive to investors who had been sitting on the sidelines the past couple of years.1
In 2023, global bond ETF inflows rose 25%, hitting a record $333 billion.2 In the fourth quarter alone, global inflows were up 42% over the third quarter.3
Even with ongoing volatility in economic data and bond markets, we believe that investors may still want to consider moving back into fixed income. Why? Despite the uneven and halting descent in inflation around the world, global central banks may still be nearing the end of a tightening cycle designed to quell the most significant surge in inflation in decades — a cycle that made cash attractive.4
In our view, policy tightening is still not a question of “if” but “when,” and investors, accordingly, may want to consider moving back to fixed income. History tells us that investors can miss out on locking in higher yields if they wait for a clear, definitive answer on rate cuts.5
Instead of trying to time the markets (which is near impossible), investors may consider beginning to move ahead of announced changes in central bank policy rates, and increasing fixed income exposure by putting cash to work with bonds.
Bond ETFs are increasingly resonating with investors — reaching $2 trillion in assets in July 2023. We believe this market will triple to $6 trillion by 2030 as more investors view ETFs as a powerful way to access the bond market.
Figure: Actual and projected growth of global bond ETF AUM (USD trillions)
Source: From proprietary research. BlackRock projections as of 31 March 2024. Subject to change. The figures are for illustrative purposes only and there is no guarantee the projections will come to pass.
All '$' signs refer to USD.
SEEK TO CAPTURE HIGHER RATES
Promising trends are popping up for investors who are looking past the clouds of uncertainty on timing. Bond yields are higher today than they were 20 years ago.
Figure: Yield levels of global fixed income exposures (%), 2004-2024
Source: Bloomberg, as of 29 March 2024. Yield to worst as of 31 March 2004, 31 March 2020, and 31 March 2024. US Treasuries: Bloomberg US Treasury Index; US Mortgages: Bloomberg US MBS Index; Global IG Corporates: Bloomberg Global Agg Corporate Index; Global Aggregate: Bloomberg Global Aggregate Index; Global High Yield: Bloomberg Global High Yield Index. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.
The market will continue to debate the timing of rate cuts, but few would debate that cuts will eventually come if inflation continues to moderate and policy becomes ever more restrictive as a result. Historically, longer term yields have moved ahead of policy shifts. Investors who wait for a definitive answer may miss the opportunity to capture yields at these levels.
TIME TO GET OFF THE SIDELINES
Over $1 trillion poured into money market funds globally in 2023, and the amount of cash held worldwide in money market funds sat at $9.2 trillion through year-end, up 19% from 2022.6
Bonds are called fixed income for a reason. While cash has provided income temporarily during this tightening cycle, over the long-term, cash has not provided the same level of potential ballast and portfolio diversification against riskier assets such as equities.
Figure: Money market fund average annualised returns (%), 2001-2002 rate cut cycle
Source: Morningstar, as of 31 March 2024. Money market fund returns represented by the Morningstar Prime Money Market Fund Category from March 2001 to July 2002. Average annualised return is the average annual rate of return over a given period. Past performance does not guarantee or indicate future results.
Many investors are still significantly underweight to fixed income, with a 21% average fixed income allocation, based on global industry assets under management.7
HOW TO GET BACK INTO BONDS
Harnessing the power of bond ETFs
For investors considering bonds again, how could they implement their fixed income allocation?
- Utilise a bond investing toolkit. There are many ways to invest in fixed income including: individual bonds themselves, mutual funds, closed-end funds, separately managed accounts, and bond ETFs.
- Adopt a portfolio mindset. Investors are now able to use low-cost index exposures at the core, while employing active strategies to seek enhanced returns. For example, index bond ETFs are liquid, transparent, and efficient, making them good building blocks for the core of a portfolio. At the same time, active bond ETFs can augment this portfolio by providing the potential for enhanced return and diversification of opportunities.
Investors can benefit from bond ETF innovation. With over 2,300 bond ETFs globally, investors today have more choices and tools than ever.8 Newer bond ETFs are slicing the fixed income marketplace into ever more granular exposures that can be blended into highly customisable portfolios. Read the full paper to learn more about the breadth of the fixed income ETF toolkit.
