Winter 2023

Case Studies in Fixed Income – From Objective to Execution

Managing bond portfolios can be resource consuming for multi-family offices and investment counselling firms. The extensive time and energy devoted to security selection and trading may not provide proportionate benefits, and the time investment may be disproportionate to the returns.

Jan. 17, 2023

Managing bond portfolios can be resource consuming for multi-family offices and investment counselling firms. The extensive time and energy devoted to security selection and trading may not provide proportionate benefits, and the time investment may be disproportionate to the returns. Mark Webster, Director, Institutional & Advisory, BMO ETFs, makes the strong case that fixed income ETFs can be used to more efficiently achieve investment objectives, ensuring superior execution and providing the flexibility to align exposures quickly as market conditions present opportunities.

Fixed income is a difficult asset class which demands tremendous time and energy relative to the returns it provides. Given this consideration, individual bond management may not be suitable for firms with constrained resources. In evaluating fixed income performance, macro decisions like term and credit quality are infinitely more important than the bonds that get you there.1

Multi-family offices and investment counselling firms should incorporate fixed income ETFs into like those offered by BMO Global Asset Management, Canada’s largest fixed-income ETF provider2, their portfolio management to provide greater depth, consistency and flexibility. Regardless of size, investment counsellors lack the scale to manage bonds as effectively as large pension plans. As a result, they face capacity and liquidity constraints which may add significant operational burdens and possibly additional compliance costs if they are forced to buy too many different issues to achieve their objectives.

Bond ETFs have evolved significantly since the first Universe Index ETF was listed almost 20 years ago. Precise exposures are now available — portfolio building blocks that can provide defined access to specific points along the yield curve:

  • Short-term, mid-term and long-term;
  • Federal, provincial and corporate;
  • Canadian mortgage-backed securities, providing AAA-rated bonds but with slightly lower duration and slightly higher yield;
  • Corporate bonds divided between A-rated bonds and BBB-rated bonds;
  • Short, mid and long-term U.S. Treasuries;
  • US TIPs;
  • Short and mid-term U.S. corporates, U.S. high yield & floating- rate high yield; and,
  • Emerging market sovereign bonds (Debt-to-GDP weighted).

With finely defined, consistent exposures, bond managers can spend their time analyzing macro data and then express their desired exposure using ETFs to achieve their objectives. ETFs have three levels of liquidity (bonds have one), so they provide additional avenues to trade in an otherwise opaque and constrained asset class.

How an ETF trades – access to 3 levels of liquidity

How an ETF trades – access to 3 levels of liquidity
Source: BMO Global Asset Management.

We recently broadcast an institutional fixed-income webinar featuring a leading market maker, a senior fixed income manager from a defined benefit pension plan and our head of strategic partnerships, who is a former bond manager. With a battery of real cases to examine, we discussed the investment thesis behind large block trades to ascertain why the ETF was an optimal vehicle to achieve an objective.

To preface the discussion, we noted that the Bank of Canada, The Federal Reserve and the Bank of England had all published reports which validated the benefits ETFs bring to managing fixed income. In the U.S., the National Association of Insurance Commissioners has approved over 175 fixed income ETFs for use in insurance general accounts to facilitate investment, operations and oversight.3 In addition, the Chicago Mercantile Exchange accepts five different fixed income ETFs as collateral for derivatives contracts, noting the operational advantages they provide. Bonds mature, but bond ETFs are open-ended, resulting in significant administrative improvement for all parties.

COVID crisis bond congestion

Equity markets had their share of difficulties as COVID hit Western economies, but they continued to trade transparently on exchanges. The bond world, however, was highly congested. At one point in Canada, 70% of provincial bonds and all corporate bonds went no-bid, making it impossible to value or to trade individual issues.

During this paralysis, fixed income ETFs, trading transparently on exchanges like equities, continued to trade. The ETF provided price discovery and, equally important, execution. Market makers continued to post bid-ask spreads for bond ETFs even when the underlying securities could not be priced. 

A large institutional investor chose to rebalance from fixed income into equity and executed a $203 million aggregate bond trade at NAV, despite the problems in the underlying market:

Using ETFs in times of extreme market turbulence – a case study

  • ETF: BMO Aggregate Bond Index ETF (ticker: ZAG).
  • Date: March 27, 2020 (“March Meltdown”); many bond desks on the street were going no bid at this time.
  • The Trade: An institutional client came in, seeking liquidity by selling 12.8MM shares (~$203MM) of ZAG.
  • Execution: This trade was done as a NAV trade, and the client received NAV flat pricing. This trade was printed on exchange at 8am on March 30th. (Typically, NAV execution will go up pre-market on the next trading day.)
  • Other Considerations: ZAG’s NAV is marked to index mid. Therefore, this client was able to sell over $200MM of risk at mid-market in a single transaction, in one of the most turbulent times in financial history. Further, since most traditional bond market liquidity had dried up, a lot of the markets in the index were stale and lagging true fair market value, which means the client actually likely did much better than mid-market.
ZAG CN Equity
Source: BMO Asset Management Inc., March 30, 2020. For illustrative purposes only.

Working in concert with market makers, the investor was able to execute their investment objective in spite of obstacles in the underlying market.

Precise fixed income exposures facilitate macro decisions – term credit and duration

As previously noted, security selection in fixed income has a very muted benefit, but it is vital to evaluate term, credit & duration to manage risk and returns. Segmented fixed-income ETFs allow managers to express their preferences with the same accuracy, knowing the execution cost before the trade is made, limiting buyer’s remorse which may occasionally occur when trying to trade individual issues. The trade highlighted below provides very simple, cost-effective execution, maintaining credit quality but managing the term and duration to align with the institution’s liabilities: a single trade out at NAV and a single trade in at NAV {trade times: BMO Short Federal Bond Index ETF [ticker: ZFS] – 2 hours and 2 minutes; BMO Long Federal Bond Index ETF [ticker: ZFL] 1 hour and 13 minutes)4.

ETFs are an efficient tool to make large duration changes

FundOrderQuantity$NAVCostExecuted Price
ZFSSell16.52MM$219,395,51213.287155 bps13.2806
ZFLBuy18.42MM$267,689,16413.7636315 bps13.7842
$487,084,676 10 bps

Source: BMO Asset Management Inc., November 2022. For illustrative purposes only.

  • Client Objective: Extend duration
  • Client owned ZFS and wanted to extend duration by switching into ZFL. This is an excellent example of how a client can use ETFs to execute a significant duration extension (total trade: $487MM).
  • Client ONLY had to execute two trades (sell ZFS/​buy ZFL) to move diversified risk exposure from short-term bonds into long-term bonds, during a period of constrained liquidity (Negative U.S. CPI Print on September 13 created a risk-off tone in the market).
  • Client had full transparency on cost (10 bps) and executed two NAV trades. These trades were executed at NAV +/- cost, and were done completely anonymously (no information leakage).
  • Using ETFs enabled the client to execute this trade without having to trade a single bond in the cash market, and ensuring there was no cash drag or market slippage keeping their portfolio fully invested throughout the transition/​execution process.


Operational effectiveness is important for all organizations, but absolutely vital for fiduciaries like multi-family offices and investment counsellors. In most instances, investment counsellors use fixed income to provide stability to the risk assets in a portfolio. Outperformance is not an overt objective, so extensive time and resources devoted to security selection and trading may not provide significant returns nor scalability as the business expands.

To achieve optimal efficiencies, fixed income ETFs can be used to express investment objectives, ensuring superior execution and providing the flexibility to align exposures quickly as market conditions present opportunities.

Please contact your BMO ETF Specialist for more information. Our Portfolio Managers are also available to help with trading insights. They can also be reached at 18777417263.

1 eVestment Active Core universe performance versus the Bloomberg U.S. Aggregate Bond Index as of March 312017.

2 Canadian ETF Association (CETFA) Monthly Report, Canadian ETF assets as of December 312021.

3 National Association of Insurance Commissioners (NAIC), SVO-Identified Bond ETF List: ETFs Eligible to be Reported as Bonds,” December 312021.

4 BMO Asset Management Inc., November 2022.

Any statement that necessarily depends on future events may be a forward-looking statement. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Although such statements are based on assumptions that are believed to be reasonable, there can be no assurance that actual results will not differ materially from expectations. Investors are cautioned not to rely unduly on any forward-looking statements. In connection with any forward-looking statements, investors should carefully consider the areas of risk described in the most recent simplified prospectus.

The viewpoints expressed by the authors represents their assessment of the markets at the time of publication. Those views are subject to change without notice at any time without any kind of notice. The information provided herein does not constitute a solicitation of an offer to buy, or an offer to sell securities nor should the information be relied upon as investment advice. Past performance is no guarantee of future results. The statistics in this update are based on information believed to be reliable but not guaranteed.

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