Discover how fixed income ETFs can offer compelling opportunities for income generation, portfolio diversification and risk mitigation.
Whether you’re seeking additional income or want access to diverse sources of return potential across the credit spectrum and capital structure, fixed income ETFs can offer exposure to both index-based and actively managed ETFs, providing potential expansive solutions to help investors reach their investing goals.
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Backed by the world's strongest and largest economies, developed market government bonds are among the safest and most liquid asset classes. Government bonds tend to perform well in turbulent times and can help diversify risk in multi-asset portfolios. Often viewed as a possible buffer for volatile equity and other riskier markets, government bonds serve as a core allocation for investors.
Investors wanting higher yields than they could get from government or investment grade corporate bonds would normally have to invest in bonds from issuers with lower credit ratings. Less financially secure issuers must pay higher coupons to compensate bond investors for the additional risk they’d be taking, i.e., the risk of the issuer being unable to pay the coupons or the principal. While this trade-off is agreeable for some investors, others are unable to accept this higher default risk.
Fortunately, more innovative solutions are now available. While they are not without risk, innovative income ETFs can offer investors the potential for higher yields without having to necessarily accept lower credit quality at the issuer level. These securities are often from investment-grade issuers, with the higher coupons driven by their subordination and other features, not the company’s credit rating.
Investor appetite for Environmental, Social and Governance (ESG) solutions across all asset classes has grown rapidly in recent years. Within fixed income, most of the focus for ESG investors is in the corporate bond space. In addition to providing exposure to companies operating in a variety of sectors, corporate bond ETFs offer choices such as targeting different maturities, currencies or credit quality.
Fixed income ETFs give investors access to bonds and other fixed income securities, such as US Treasuries, corporate debt, municipal bonds, and floating rate notes. Some potential benefits of fixed income ETFs include cost effectiveness, liquidity, portfolio transparency, and diversification.
Since bonds are generally not as volatile as other assets, like stocks, they can serve as ballast for an overall portfolio. In particular, ETFs that invest in high quality bonds, like US Treasuries and investment grade rated debt, may help provide portfolio stability. When market uncertainty leads to disruption in the equity markets, fixed income ETFs may provide diversification benefits. Within fixed income ETFs, strategies with lower duration may help preserve capital when interest rates rise.
As their name suggests, many investors use fixed income ETFs to generate income. Some of the bond asset classes that fixed income ETFs hold are traditionally used to seek overall portfolio stability because when market uncertainty leads to disruption in the equity markets, bonds may provide some diversification. Investors can also use specialized fixed income ETFs to help diversify their sources of income as well as help tailor their exposure to credit and duration risk.
Subordinated bond ETFs target exposure to higher-yielding segments of the fixed income market. AT1 CoCo Bond ETFs and Euro Corporate Hybrid ETFs focus on Additional Tier 1 (AT1) contingent convertible bonds and European corporate hybrid debt, respectively; two areas that are known for their income potential and structural complexity. These ETFs are designed to provide diversified access to instruments that sit lower in the capital structure. AT1s are a type of hybrid debt instrument primarily issued by European banks as regulatory capital. They sit just below senior debt within the capital structure, and it is this subordination that drives their higher yield rather than the riskiness of the issuer. Corporate hybrid bonds are similar to AT1s in many ways, including often being issued by companies with strong balance sheets and investment-grade credit ratings. The most obvious difference is that AT1s are only issued by financial institutions whereas corporate hybrids are issued by utilities, telecoms and companies in other non-financial sectors. Corporate hybrids can be appealing for the issuing company because credit rating agencies treat them as part debt/part equity, meaning they can support the issuer’s credit metrics.
AAA CLOs are investment grade securities. A CLO is a special purpose vehicle (SPV) securitised by a pool of assets, including senior secured leveraged loans and bonds. Distributions from the pool are paid out to the CLO’s obligations based on a cashflow waterfall, with first flow to the highest debt tranche of the CLO and continue to the lowest debt tranche followed by the equity. AAA CLO notes are the highest rated tranche of the CLO structure.
These are investment products that aim to deliver returns based on overnight interest rates, typically used for short-term cash management and capital preservation, especially in volatile markets. €STR (Euro Short-Term Rate), SOFR (Secured Overnight Financing Rate), and SONIA (Sterling Overnight Index Average) are official overnight interest rate benchmarks used in Europe, the US, and the UK. They reflect the cost of very short-term borrowing between banks and other financial institutions, and are considered reliable indicators of central bank policy and market liquidity.
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