A guide to active fixed-income ETFs

Actively managed fixed-income ETFs are growing fast. We believe the strong case for active management in bond portfolios and further innovation in fixed-income ETFs will continue to drive this trend for years to come.

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Fixed-income ETFs hit $1 trillion

Assets in U.S.-listed ETFs ended 2020 with about $5.5 trillion, with about 75% of that in ETFs that invest in stocks. However, fixed-income ETFs are seeing rising adoption as category assets rose above $1 trillion last year.¹

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U.S. equity ETFs had a significant head start with the first listing in 1993. The first fixed-income ETF didn’t appear until nearly a decade later in 2002, and the first actively managed ETFs hit the market in 2008.

Yet, bond ETFs are catching up to their equity cousins for several reasons. One factor is that investors and financial professionals are simply getting more comfortable with investing in bonds through ETFs. In recent pieces on the “Viewpoints” section of our site, we’ve tried to debunk some of the misconceptions around bond ETF premiums and discounts in volatile markets.

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Investors are also generally warming up to the benefits of ETFs, including lower costs, liquidity, and tax efficiency. And within bond ETFs, specialized strategies and active management are proving popular as investors find it difficult to generate income and worry about the impact of rising interest rates.

Active versus passive in bond ETFs

We think the changing composition of the U.S. bond market in the past decade is an important dynamic for actively managed fixed-income ETFs, especially core strategies. Passive, index-linked core approaches have become much more concentrated in government debt and are more vulnerable to higher rates due to their longer duration.

Due to the U.S. Federal Reserve and quantitative easing, the size of the U.S. Treasury market has ballooned. For example, at the end of February 2021, Treasuries accounted for about 39% of the Bloomberg Barclays U.S. Aggregate Bond Index.²

Meanwhile, the duration of the Bloomberg Barclays U.S. Aggregate Bond Index has steadily risen since the global financial crisis to more than six years currently.² This means that index-based core strategies carry a fair amount of interest rate risk.

Also, interest rates are still incredibly low on a historical basis. This means investors in search of more yield need to explore other bond asset classes such as floating-rate loans, securitized assets, high-yield bonds, and non-U.S. bonds. This in turn tends to require credit research, security selection, and portfolio construction. For that reason, we believe an active approach makes sense for bond ETFs.

Active fixed-income ETFs are ripe for growth

There has been significant innovation in bond ETFs in recent years to meet investor demand for specialized strategies due to low interest rates and the potential risk of passive core approaches. More well-known bond managers are introducing active ETFs, while investors and financial professionals have grown more comfortable with fixed-income ETFs. We think the next round of bond ETF growth will be driven by managers with proven track records, solid security and sector research, and close attention to risk management.

 

Morningstar, as of 12/31/20. 2 Bloomberg, as of 2/28/21.

The Bloomberg Barclays U.S. Aggregate Bond Index tracks the performance of U.S. investment-grade bonds in government, asset-backed, and corporate debt markets. It is not possible to invest directly in an index.