"$235B Net Purchases!"

Despite the recent frenzied sell-off of U.S. Treasuries, which has led to substantial losses for long-term bond holders, bond ETFs have attracted a record inflow of funds in the first three quarters of this year...

As the market anticipates that interest rates will remain high for a longer period, investors have been flocking to fixed-income ETFs (Exchange Traded Funds) this year to obtain higher yields, despite a general sell-off in the bond market.

Data compiled by BlackRock shows that in the first three quarters of this year, fixed-income ETFs listed in the United States and Europe attracted a record inflow of $235 billion, higher than the $169 billion in the same period last year and the $222 billion in the same period in 2021.

This trend continued in October, with a net inflow of $13.4 billion in the first 13 days of the month, despite a broader sell-off in fixed-income products as investors prepare for a sustained rise in interest rates. Analysts say that fixed-income ETFs have attracted inflows because the higher yields they offer are attractive, and this tool is becoming increasingly popular as an investment vehicle, with increasing use in model portfolios.

Ben Seager-Scott, head of multi-asset funds at Evelyn Partners, explained, "Currently, there is a lot of interest in fixed-income ETFs because they are a way to easily access an asset class with increasingly attractive yields."

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However, the continued rise in yields has depressed prices, causing significant losses for investors holding long-term bonds. The iShares ETF holding 20-year or longer U.S. Treasury bonds has fallen by 12.9% this year.

"The sell-off since the summer has caught many investors off guard," said Antoine Lesne, managing director at State Street Bank, "But for (longer-term) investors, these levels may still be attractive."

As central banks have maintained the fastest pace of interest rate hikes in a generation, prices have fallen. Since the beginning of 2022, the Federal Reserve has raised rates by more than 5 percentage points, to a range of 5.25%-5.5%.

In recent months, the unexpected resilience of the U.S. economy has pushed up U.S. Treasury yields, making investors realize that interest rates may remain at higher levels for a longer period. Concerns about the number of bonds the government plans to issue in the coming year, as central banks seek to reduce their balance sheets, have also pushed up government bond yields.

Most of the inflows on both sides of the Atlantic have gone into sovereign debt ETFs with higher credit ratings. In the year ending October 9, U.S. Treasury ETFs attracted just over $100 billion in funds.A significant portion of the funds has flowed into products holding short-term bonds. In the United States, the yield on these bond ETFs has consistently been higher than that of longer-term bond ETFs, as investors have priced in the expectation that interest rates will begin to decline next year.

Rohan Reddy, Head of Research at fund management company Global X, stated, "It makes sense for investors to focus on 1-3 month bond ETFs due to the short-term interest rates being significantly higher than long-term rates." This trend reflects a substantial influx of investors seeking cash alternatives into money market funds this year.

However, the inflow of funds into ETFs holding longer-term bonds has also been healthy this year. Data from TrackInsight shows that iShares' Treasury ETF with a maturity of over 20 years has been the best-selling fixed income ETF this year, attracting $17.9 billion in funds in the year ending October 18.

Moreover, despite the recent underperformance of fixed income products, strategists anticipate that investors will continue to invest in such products, as they are underweight in this asset class following a prolonged period of extremely low interest rates.

Brett Pybus, Global Co-Head of iShares Fixed Income ETFs at BlackRock, said, "I believe we are in the early stages of reallocating funds to fixed income products." He added, "Our analysis shows that the average fixed income allocation in the portfolios of our clients in Europe, the Middle East, and Africa has increased by 10%."

However, as the impact of rising global interest rates begins to take effect, investors have become more cautious about investing in high-yield bond ETFs, as the risk of default has been increasing and more companies are being forced to refinance at much higher interest rates.

Sig-Scott from Evelyn Partners stated, "I believe that high-yield bonds should be avoided at this stage of the cycle, but there will come a day when they will be attractive again." TrackInsight data shows that high-yield bond ETFs experienced a net outflow of $1.3 billion in the year ending October 2, while investment-grade bond ETFs saw inflows of over $200 billion.

Some investors have chosen to hold government bond ETFs linked to indices in order to lock in returns ahead of inflation.

Kevin Flanagan, Head of Fixed Income Strategy at WisdomTree, said, "From our perspective, investor funds have been flowing into U.S. Treasury floating rate notes." The duration of floating rate notes is only one week, essentially making them one of the highest yielding Treasury securities.