The rise and rise of fixed income ETFs

Paul: [00:00:00] Welcome to Index Ideas from FTSE Russell. I'm Paul Amery, your podcast host. In the podcast we explore index ideas that can help you address real-world investment themes and challenges. The concepts that we discuss in the podcast are not investment advice. They represent transparent, systematic approaches that may be developed into indices and made available for broad public use. Any reference to potential strategies is therefore intended for informational and educational purposes only. In this episode of Index Ideas, I'm joined by Jack Fischer, who is US Fixed Income Product Lead at FTSE Russell. It's been a busy year in the fixed income markets and Jack is here to tell us why. Jack, welcome to the podcast. Let's talk about the fixed income market from an ETF and a US perspective. In August we saw record flows into US fixed income ETFs. What drove that trend?

Jack: [00:00:51] Yeah. Hey Paul thanks for having me. Yeah. So, full caveat: this will be from a US lens, so I'll be talking about US-domiciled funds. But yeah you're right, absolutely, there's been record inflows into US fixed income ETFs. We saw about $42 billion into US fixed income ETFs: passive making up about 27 billion of it; active, another 16. You know, first and foremost the ETFs are just a force to be reckoned with. The last monthly outflow for fixed income ETFs was back in February of 2023. You know, even during 2022, which was the worst year on record for taxable fixed income performance and second worst for tax exempt performance, ETFs found a way to survive. You know, they're a wrapper that provides a broad range of solutions to the market, and they've been adopted at a record level since the start of the year. You know, second the macro backdrop and technical lens is really poised for income-oriented investors. You know, there's uncertainty around the impacts of tariff policies on corporate balance sheets, monetary policy on pricing levels. You know, and with yields across fixed income sectors above five-year averages. You know, it's just an attractive point for investors to get into the fixed income market.

Paul: [00:02:10] Could you talk a bit more about the split between active ETFs and index ETFs? Because that's something that's quite distinctive, isn't it? In the fixed income market, you've got quite a high share of active products. And this year it's been about I think you said it's about one third active, two thirds index based. What trends do you see there? Do you think that's going to continue at that split?

Jack: [00:02:32] Yeah. So you know everything that's coming to market is more active. So new products have been more in the active world. The active products that are attracting flows have been products that have been in market. You know, I think one of the things that these new active products are going to have to get over is building up a good track record. You need a good track record to entice investors to buy into the strategy. So the main flow getters this year, have been JAA, which is a floating rate CLO product, BINC, multi-sector and the other was JPST, which is ultra-short. So those are the categories and classifications where active management has tended to do better. You know, they do well in those non-index positions, you know, thanks to their credit research teams.

Paul: [00:03:25] You mentioned international income funds. So from a US perspective that means non-US fixed income. Is that right?

Jack: [00:03:32] That's right.

Paul: [00:03:34] So those funds have been seeing record inflows I think five months in a row by the end of August. Presumably that's dollar weakness that's driving that. Or is it something else?

Jack: [00:03:43] Well like everything there's a multitude of factors. So they've hit record AUM for five straight months. They've seen 13 billion. The passive side has seen 13 billion in year-to-date flows. You know there's BNDX, there's IAGG, which are the two largest ETFs in this part of the market. Those have seen over 4 billion in year-to-date flows. The growth is broad-based. There's IGOV, there's ISHG, which are two products that track FTSE Russell indices, that have more than doubled in size since the start of the year. And to answer your question, in terms of investor motivations, you know, part of it is share dollar weakness. But a lot of those strategies and a lot of the conversations we have with clients are still hedging back to the US dollar, so taking out a lot of that local currency risk. I think it has more to do with the overall divergence in global policy. So different parts of different markets are attacking growth scares, inflationary pressures in a different way. You pair that with how tight fixed income spreads are in the US market. Portfolio managers and investors are just looking for opportunities. And they're using the global stage to source those opportunities.

Paul: [00:04:52] If for a US-based investor who is looking to diversify outside his or her domestic market into international fixed income markets, how should they balance the desire for diversification with potential concerns over liquidity? Maybe the markets are not as deep outside the US. When you're talking to FTSE Russell clients, how do you address that topic?

Jack: [00:05:15] I mean, that's a great question. It's a very loaded question because there's a lot that goes into designing these indices and these products fit for market. So yeah, while international income may sound like a very straightforward classification or strategy, there are various nuances like currency market exposure. So our world broad investment grade index, our [FTSE] WorldBIG has 16 currencies in that index. If you look at other competitor global core products they have about 26 currency markets. Now that difference of ten really is the less liquid, less tradeable markets. And those tend to add more noise than value. Now all of this gets wrapped into our governance process. We have a semi-annual committee that reviews these types of market accessibility metrics.

Paul: [00:06:11] This is the fixed income country classification process, where the committee meets every half year to review which markets make it into the relevant indices and which don't.

Jack: [00:06:21] That's right, that's right, that's right. So when we do that in partnership with our clients and with boots on the ground, so we get a sense of, we take pride in making that process transparent. So we get feedback from the local markets. And we plug that into our framework to determine, whether a country is fit for the WGBI, our World Government bond index.

Paul: [00:06:45] Right. So, of the FTSE Russell index products that you've been discussing, or that might enable US-based investors to diversify outside the home market, which are the most popular index products or indices that people are looking at?

Jack: [00:06:59] Yeah. So the World Government Bond Index is certainly seeing a record level of attention. I've never seen this much focus on international allocation before. And the WGBI, which is our flagship government bond index, is front and centre, whether it's asset owners or whether it's asset managers. They're looking at ways to gain access to international sovereign debt in a modern way. So there are other considerations that are being involved here, whether to cap certain markets or whether to exclude certain markets, obviously, whether to hedge certain currencies. One index, one product that I find interesting and the one that we've been playing around a lot more with is this debt capacity, GDP-weighted version of the World Government bond index. So what that does is it overweights/underweights various currency markets based on the country's ability to pay back its own debt. And so what that naturally does is it underweights the US, underweights Japan, underweights China relative to the base index.

Paul: [00:08:05] Right. So the WGBI is celebrating its 40th anniversary, I believe, in January 2026. So just a few months away. But you're saying that there are variants of the parent index that people can consider, they don't have to go for the market cap-weighted standard index.

Jack: [00:08:22] That's right, that's right. And it all comes down to investor preference and risk tolerance. But, there are certain variants that will naturally weight certain parts of the market.

Paul: [00:08:32] And any other indices you'd like to mention others involving with corporate bond exposure. Or are people looking much at inflation-linked products. What other trends are you seeing: developed versus emerging markets?

Jack: [00:08:45] Yeah. So, emerging markets is another one that we have EMUSDGBI, so it's a government bond index for emerging markets. One thing—it was a recent article from an asset manager who talked about index provider standardisation across the equity side and the style box there. And I think that same framework applies when you look at international fixed income. If you have a standardised framework of developed versus emerging markets, it helps standardise your book of rate exposure. It helps build a process for due diligence. So our emerging market index, within that vein of standardisation, has also received a lot of attention. Emerging markets have seen some inflows more towards the hard currency. So the US dollar-denominated EM products. But another one again, that is an area where US investors are looking for opportunities on the global stage.

Paul: [00:09:43] And a final question on pricing and price sources. This is not as standardised in fixed income as it is in equity markets where indices are typically built using exchange closing prices. So there's not really much debate about what those are. But in fixed income, it's not necessarily as standardised. Could you explain a bit about how we do that?

Jack: [00:10:00] Yeah. So fixed income markets have come a long way in terms of pricing and getting access to dealer data to be able to price certain bonds. As an index provider, pricing is one of the most important things we can offer. And we have a great relationship with Tradeweb, who prices a lot of our index. They priced the euro gov. They priced UK gilts. They priced US treasuries. So they use market-derived data to help price those specific bonds. Without that level of transparency, you can't mark an index, you don't know where the portfolio stands on a day-to-day basis. And that has a lot of effects in terms of how asset manager manages their risk. So pricing is one of the key considerations for index providers. And it's even more important when you look at a global portfolio.

Paul: [00:10:52] Great. Well Jack, thank you very much for sharing your views with me today. That's it for this episode. If you've enjoyed the conversation on Index Ideas, then please do follow us and give a positive rating or review on your podcast platform of choice. And if you'd like to get in touch with the show, you can do that via the email fmt@lseg.com. But for now, from me, Paul Amery and from Jack Fischer. Goodbye.

Jack: [00:11:16] Thanks, Paul.