Markets

Lisa Abramowicz is a Bloomberg Gadfly columnist covering the debt markets. She has written about debt markets for Bloomberg News since 2010.

A Deutsche Bank investment arm thinks it has an "innovative" solution to a big problem.

The $804 billion money manager is late to the fastest-growing segment of debt investing, exchange-traded funds. And its assets have shrunk at a time when passive investing is hot and active is not. So it's trying to break into one of the brighter spots in the ETF industry.

Shrinking Assets
Deutsche Asset Management is looking to break into the debt ETF industry as its assets shrink
Source: Quarterly filings, Bloomberg

Deutsche Asset Management just launched its Deutsche X-trackers USD High Yield Corporate Bond ETF, Sridhar Natarajan and Rachel Evans of Bloomberg News wrote in an article on Wednesday. It looks like a lot of other funds in the $53 billion junk-debt ETF market, which has been a magnet for big and small investors alike. Its main selling point is a bargain-basement price. The new Deutsche Bank fund is offering an expense ratio of 0.25 percentage point, the lowest among 50 such ETFs.

“Sometimes the management fee is the innovation and this is an example of that,” Luke Oliver, the head of ETF capital markets at Deutsche Asset Management, said in an interview with Bloomberg News. “Within the fixed-income space this is a new factor.”

Such low fees may be new to fixed-income ETFs, but they're not so novel everywhere else.

Essentially, this is the debt-investing version of buying generic laundry detergent instead of Tide, or store-brand sugar instead of Domino. It's an age-old exercise of commodity price versus brand value. But in the debt market it will be an important case study about who uses high-yield bond ETFs and how, an exploration of fee versus function.

Let's assume this new Deutsche ETF effectively replicates its benchmark index and performs similarly to others. If it fails to raise much money, that'll suggest that the bulk of high-yield bond ETF investors are using the funds more for liquidity management and trading purposes than simple longer-term exposure to the market. 

Consider the biggest high-yield bond ETF, BlackRock's $16.9 billion fund. It has spawned an entire ecosystem of trading. Options are tied to the fund's shares, and they're easily and frequently shorted. Brokers and investors have systems programmed to identify bonds that can be used to create or redeem shares in the fund.

Critical Mass
The two biggest high-yield bond ETFs have attracted the vast majority of flows among similar funds
Source: Bloomberg

Many institutions use the funds to quickly gain exposure to the entire $1.3 trillion U.S. junk-bond market as they search for the right specific bonds to buy. Big Wall Street banks use the ETFs to support their market making in addition to holding specific bonds in their inventories.

But a rush of money into the new Deutsche fund would signal that the longer-term set is outweighing the fast-moving traders, attracted by the low fee. And here's where it could get truly interesting: If the new fund amasses a critical amount of assets and activity to offer ease of trading similar to bigger existing funds, it could spur a race to the bottom that forces those other ETFs to lower their costs or risk becoming irrelevant.

Other than the trading aspect, there's no apparent reason for investors to stick with an ETF that charges higher fees if one promises the same thing for a lower cost. If the trading aspect comes into play as well, rivals will need to watch out. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Lisa Abramowicz in New York at labramowicz@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net