As advisors know, these are calamitous times in the bond market. Just weeks removed from 30-year Treasury yields ascending to their highest levels since 2007, 10-year yields briefly moved above 5% for the first time since 2023 on Monday, Sept. 14.
Moves like that are problematic for the scores of clients and retail investors relying on basic, usually passively managed low-cost aggregate bond funds that are heavily allocated to the very Treasuries (and other bonds) that are proving most vulnerable in the current environment.
Fortunately, there are some silver linings. Those include history, which indicates that the higher an investor’s starting yield is, the better theirs odds are of long-term success. Additionally, today’s high bond yields imply that fixed income has credible inflation-fighting power and that there’s value to be had in the space.
So yes, there’s very much as case for the union of active management and fixed income today – one that ETFs make easier and more cost-effective to embrace.
With Bonds, Plenty of Active of Allure
Fixed income has long been as prime territory in which active managers can strut their stuff. After all, some corners of the bond market are illiquid (emerging markets, munis, senior loans), making them more conducive to active management than indexing.
Yes, there have been notable benefits in the active/ETF combination for advisors, clients and, of course, issuers. However, actively managed bond ETFs aren’t perfect. No security is, but with more and more eyeballs drifting to active fixed income ETFs, advisors should examine the drawbacks of these funds. Those include the propensity of active bond ETFs to trade at premiums or discounts to their net asset values more frequently than passively managed equivalents.
“Active bond ETFs may make sense in today’s dynamic bond market because they can respond to market dislocations and evolving risks in real time,” notes American Century’s Greg Torretti. “For investors, the ability of portfolio managers to adjust duration, credit exposure and sector allocations as interest rates, inflation and economic conditions change gives them more opportunities to capture attractive income and total return potential.”
As Torretti points out, passive bond ETFs, though often low-cost and, in many cases, homes to deep portfolios, face constraints that could hinder those funds relative to active peers. Those drawbacks include cap weighting, which forces the index into the most indebted companies or countries, credit quality concerns, constrained selection universes and index replication hurdles.
Plenty of Active Advantages
With the Fed likely to imminently raise rates, actively managed bond ETFs could take on increasing importance for advisors and clients.
“Unlike passive portfolios, active managers can adjust their exposure to interest rate risk (duration) as the economic climate changes,” adds Torretti. “This important feature may aid performance potential relative to the benchmark in rising and falling interest rate environments. This flexibility has been particularly important through bouts of interest rate volatility.”
It remains to be seen if the Fed is gentle with rate hikes (just one or two) or if a 2022-style tightening campaign materializes, but either scenario highlights the utility of active bond ETFs.
“Many investors seek to balance interest rate and credit risk in pursuit of attractive income and total return,” concludes Torretti. “Active fixed-income ETFs can help by evaluating and securing diversified sources of income in all interest rate environments. They offer the flexibility to actively adjust sector exposures and credit quality to help enhance yield and return potential and actively manage risk.”
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