Amid a global influx of capital and a constant drive for innovation, fixed-income exchange-traded funds (ETFs) are becoming increasingly numerous, accessible, and convenient. This market has recently become more transparent and automated, enabling investors to manage risk in ways they may not have been able to before.
This trend is prompting many large institutional investors to take a closer look at European fixed-income ETFs as essential tools for managing their risk and cash, as well as assessing liquidity in the fast-moving and changing credit bond market.
In recent years, investors seeking European fixed-income exposure have faced barriers to liquidity, access, and transparency. In the U.S., you can trade in deep government and corporate bond ETF markets in readily accessible and centralized exchanges. By contrast, each ETF in Europe is often listed in several countries and traded in over-the-counter transactions. Upon further examination of the underlying bond market, across European investment-grade and high-yield bonds, approximately 60% trade daily or weekly, another 30% trade a few times a month, and 10% trade barely at all. European bonds also typically have higher minimum denominations of $100,000.
However, surging investor interest and product innovation are invigorating the market. Fixed-income ETFs in Europe have now surpassed the $500 billion AUM mark, growing at a rate of more than 15% annually.
Regulatory tailwinds, such as MiFID II and ESG regulations, have all boosted demand for ETFs, growing the client base and introducing new use cases. Factors making fixed-income ETFs more attractive include the easing cycle of central banks, the rebalancing away from dollar assets into euro assets, and the pace at which the market tends to move. By 2030, we forecast that the global fixed-income ETF AUM will grow to $6 trillion, with actively managed fixed-income ETFs exceeding $1.5 trillion.
Many of the new entrants to this market in recent years are global macro and systematic hedge funds, central banks, sovereign wealth funds, large asset managers, and a growing portion of retail aggregators.
The market has also quickly moved beyond simple index mainstream trackers. Now, providers offer a wide variety of fixed-income ETFs, including core, active, tactical, duration-managed, and ESG-focused options. New offerings hit the market regularly, becoming increasingly sophisticated to deliver access to every corner of the fixed income market. For example, it was only within the last three months that the Jefferies fixed-income ETF desk began to encounter and trade AAA-rated CLO ETFs and private credit ETFs.
When institutional investors decide to trade in European fixed-income ETFs, they derive significant benefits from working with an authorized participant that has extensive experience in this market.
Authorized participants can facilitate large block trades directly with ETF issuers through the primary market, independent of the volume available in the secondary market, according to State Street.1 This is especially important for fixed-income ETFs, where large orders might otherwise move market prices or not be fully executed on the exchange.
Additionally, authorized participants can help ensure that ETF prices remain close to their net asset value by creating or redeeming shares in response to supply and demand imbalances, according to VanEck.2 This reduces the risk of trading at a significant premium or discount. By trading directly in the primary market, authorized participants can achieve more cost-effective large transactions, as it avoids the bid-ask spreads and market impact costs associated with secondary market trades.
Authorized participants optimize primary bond baskets by examining the distribution of risk the ETFs are tracking across multiple factors, such as duration, spread, compression, and industry. They then select bonds within each of these risk buckets to keep the fund aligned with its benchmark or objective functions. Selecting bonds is truly at the core of this new protocol of trading. With abundant data and technology, Jefferies has developed a complex scoring mechanism to assess liquidity and momentum across tens of thousands of bonds. An authorized participant negotiates with ETF issuers by uploading a proposal for the primary basket. The ETF issuer will then respond with suggestions, pushbacks, and agreements.
When an authorized participant can act as a market maker, it can often find the best prices and provide immediate liquidity. At Jefferies, we maintain substantial capital on our balance sheet that can be readily deployed at any time for fixed-income ETFs, offering clients quotes based on multiple layers of liquidity.
The European fixed-income ETF market increasingly resembles a Damien Hirst pointillist painting, with thousands of individual dots representing multiple layers of bonds’ liquidity and alpha. It’s up to the authorized participant to see the whole picture and help clients find the best combination of options to meet their alpha generation, risk mitigation, and liquidity needs.
