From April to the end of September, European investors have poured a net €3.3bn into government bond ETFs, while at the same time pulling out a record €4.3bn from actively managed government bond funds.
With the eurozone government bond yields at record lows, investors see very few alpha opportunities left in the asset class, “We prefer passive solutions for asset classes such as government bonds,” says Tanja Wennonen-Kärnä, a senior portfolio manager at Evli, a Finnish private bank. “Government bond yields keep moving up and down all the time, so it’s difficult to form a constructive view about this asset class,” she adds.
It’s all about the costs
The main factor explaining the diminished popularity of actively managed bond funds are the costs associated with them. With the majority of eurozone government bonds with a maturity of less than five years now trading at negative yields, every basis point of additional costs can be critical. “Active bond investments generate no alpha at the moment, with a few exceptions,” says Tristan Delaunay, CEO of Paris-based investment boutique Athymis Gestion. So why bother investing in active funds in the first place?
Unsurprisingly, Delaunay has ditched his allocation to active government bond funds altogether. “We have been underweight govvies for a long time, but when we look for safe havens we sometimes buy long-duration bonds, but exclusively in ETF form,” he says.
The use of ETFs in this space has two advantages, believes Delaunay. “You can get in and out quickly during periods of stress, and you don’t have to deal with complicated bets by the manager which can distort the defensive nature of the asset class,” he says.
“Government bond yields keep moving up and down all the time, so it’s difficult to form a constructive view about this asset class" - Tanja Wennonen-Kärnä
However, ETFs also have their downsides. Apart from possible liquidity constraints, though these are less likely to occur in relatively large government bond markets, trading costs could become problematic, and drive total yields down significantly. “A typical bid/ask spread is about 20 basis points, and you still have to add your broker costs to that,” says Delaunay. So when you are a tactical allocator changing positions frequently, even ETFs might be too costly in the long run. So you might then better decide to stay out of government bonds altogether...
It’s different for credit
In investment grade corporate bonds, where yields tend to be a bit higher than for government bonds, active funds have also been sold off over the past months, even at a much higher pace. But the €11.1bn of net outflows have hardly been replaced by passive inflows, which amounted to only a little more than €1bn over the period. But these outflows from active funds might just be a temporary setback, since investors had been adding frantically to their corporate bond holdings at the start of the year.
Click here to see a full overview of recent fund flows for all asset classes.