ETF Veterans From BlackRock, SSGA, and JPMorgan Bet on Changing Bond Markets
Exchange-traded funds have changed primary markets and how active managers run bond funds. Executives from some of the biggest names in ETFs are launching a start-up to target the next leg of the market evolution.
On its face, it’s just a start-up hoping to launch 7 more fixed income exchange-traded funds.
But the ETF veterans from BlackRock, State Street, JPMorgan Chase & Co., and others, who are launching their new firm on Thursday, have been involved in the development of fixed income ETFs from the start. They’ve witnessed how the products have changed both the way active bond managers run their portfolios and how the primary fixed income markets operate.
Now the founders of BondBloxx Investment Management are betting on the next evolution of the fixed income markets. While equity markets may be saturated with ETFs and other innovations, experts expect new opportunities to come in fixed income, including quant strategies and algorithmic trading.
BondBloxx’s filing with the Securities and Exchange Commission for a little more than a handful of high-yield bond sector ETFs is representative of what the new firm will do across asset classes, although the founders wouldn’t comment specifically on the funds.
Even though anyone can buy an ETF, BondBloxx is largely targeting institutional investors.
“Institutional investors have increased their adoption of fixed income ETFs alongside the electronification and increased price transparency that is happening in fixed income markets,” said Leland Clemons, one of BondBloxx’s founders. “Look at the intersection of these two big market trends. So then why are fixed income ETFs only 20 percent of the total ETF market?”
Clemons is the former head of BlackRock’s ETF and index investing business. He was working at BlackRock when iShares, the firm’s ETF business, first got into fixed income.
Over the summer, he and the other BondBloxx co-founders determined that what was lacking was more precise iterations of fixed income products to allow investors to make very specific allocations to manage risk.
“At their base case, ETFs were intended to empower investors with tools to build a portfolio differently,” he said. “That has occurred in equities, but hasn’t quite played out in fixed income.”
Co-founder Joanna Gallegos, former head of global ETF strategy at J.P. Morgan Asset Management and former head of ETF product management at BlackRock’s iShares, agreed. “We all see accelerated innovation in ETFs, but being 100 percent focused on fixed income gives this particular company an ability to really get this right and understand the 20 percent stat and why it hasn’t gone further until now,” she said.
Other co-founders include Mark Miller, who has previously headed institutional sales for the Americas at HSBC and led fixed income ETF sales at BlackRock, and Brian O’Donnell, who was head of sales and strategy for funds and managed accounts at Northern Trust and who previously ran U.S. cash sales at BlackRock. (Clemons and his partners declined to comment on their new firm’s backers.)
The founding team has already done much of the work of educating institutional investors about fitting ETFs into a fixed income portfolio and how to trade them. That’s behind them now, said Elya Schwartzman, another co-founder who was a senior portfolio manager at both BlackRock and State Street Global Advisors.
“Investors are now ready for them,” he said. “They just haven’t been launched yet.” Schwartzman added that there are often 35,000 securities in a broad-based fixed income fund, but only 400 ETFs.
“And really only the top 10 are taking the majority of those flows,” he added. “That’s just not the right amount of choice available for their active positioning.”
Fixed income ETFs, like their stock fund peers, were developed to mirror different segments of the market, whether high-yield or investment-grade bonds or emerging markets debt. In addition to retail investors, active institutional bond pickers used the products to quickly add to a sector they liked or whittle down some exposures without having to go into the primary markets to buy or sell individual bonds.
There was a lot of motivation to use ETFs: Unlike stocks, bonds don’t trade on an exchange, so they’ve never been easy to transact. But since the global financial crisis, the primary fixed income markets have become even more illiquid for a number of complex reasons, and that means investors can’t always easily — or cheaply — buy and sell the securities they want.
Over time, bond investors increasingly used ETFs to get around the illiquidity problems specifically and even used the products as a source of real-time pricing when they couldn’t come up with values on individual bonds. At the same time, the underlying markets were benefiting from the rise of ETFs as participants started using portfolio trading and as electronic venues finally took off after years of false starts.
Even though they have a long way to go, fixed income markets are now ripe for a lot of innovations, including algorithmic trading.
Schwartzman said portfolio trading has gotten a lot more prevalent over the last three years and now represents 5 to 10 percent of overall volume. This form of trading came about because of ETFs. Large baskets of bonds were coming in and out of the ETFs, which prompted dealers to start portfolio trading. “They take [a basket] from one ETF and then recycle bonds through an electronic venue, and that improves price transparency,” he said. “That is a virtuous circle that we can lean right into.”
Added Clemons, “You’re only now seeing this force coming into fixed income, especially in credit. Electronic trading, portfolio trading, algorithmic. We believe the confluence of that will be a real accelerant for growth.”