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High Demand for Credit Spurs Innovative Use of ETFs

A new report from Greenwich Associates examines how fixed-income managers are adapting to meet investor needs.

Increased investor desire for credit is prompting fund managers to innovate to keep up with demand, according to Greenwich Associates.

In a research report Wednesday, the Stamford, Connecticut-based asset management consultant said demand for credit has outstripped supply – a phenomenon fueling “rapid innovation” in the use of credit default swaps, exchange-traded funds, and futures.

While corporate bond issuance has risen as a result of investors reaching for higher returns than low-yielding Treasuries, the sale of the debt is being scooped up by large buy-and-hold investors. That’s left “smaller firms searching around for what’s left,” according to the report.

“Given the reduced liquidity of corporate bonds and the inability of many smaller investors to trade swaps, the ability to execute credit-related strategies remains constrained,” said Kevin McPartland, Greenwich Associates’ head of market structure and technology research, in a statement.

Pensions, endowments, and foundations plan to allocate nearly $120 billion to fixed-income managers this year, according to the report. In a survey of investment-grade investors last year, 89 percent told Greenwich reduced liquidity had at least somewhat negatively impacted their trading ability, and 90 percent of high-yield investors said the same about high-yield credit.

“Buy-and-hold corporate bond investors need tools to manage market and liquidity risk—a role that derivatives play,” Greenwich Associates said in the report. “Swaps and futures can ease the flow of credit around the system.”

Some investors have begun using ETFs as either a substitute or complement to derivatives, according to the report, which noted the largest fixed-income ETFs now have assets approaching $30 billion. Total return swaps — used for a “short-term, tactical hedge” — are another tool that’s being increasingly adopted. Greenwich Associates said the proportion of surveyed investors using total return swaps jumped from 7 percent in 2015 to 17 percent in 2016.

The consultant also said that credit index futures are “gaining traction,” particularly among investors who do not wish to trade swaps.

“Continued growth in these alternative structures would greatly enhance the liquidity and opportunity within the credit market by offering more of the multi-product liquidity and hedging access afforded to other asset classes,” Greenwich Associates said in the report.

Alex Veroude, head of credit at New York-based asset manager Insight Investment, notes that demand for credit has increased despite the potential risks involved in high-yield debt.

“Over the last two years, we’ve seen more entrants in the market, we’ve seen the existing investors in the market deploy more capital, and we’ve generally seen a loosening of credit standards,” Veroude said.

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