Steve Frazier, president of Frazier Investment Management, says he uses a mix of passive and actively managed fixed-income ETFs. According to him, the passive funds work best for clients with longer outlooks, while the active are more suited to clients with specific income-generation needs or specific volatility control or some other mandate.
For all these reasons, he says he believes actively managed fixed-income ETFs provide value over passive ones: “If I have a client who wants to generate 3-4% in income, we need to find that income somewhere. The general indexes typically aren’t going to provide that.”
Where Active Has An Edge
Morningstar’s Johnson said the high AUM and better performance of most actively managed fixed-income ETFs “tick all the right boxes.”
Active management needs to appeal to investors in that particular category, needs name recognition—a solid brand with a solid manager—and a great track record. It’s also much easier for a bond manager to get comfortable with an ETF’s daily transparency requirement than it is for a stock picker who might be managing a concentrated portfolio.
Lastly, it needs to have exposure to what’s in demand. This criterion may help explain why the short-duration fixed-income portfolios have the highest AUM in this space. Johnson says many of these funds are effectively money-market substitutes that came around in the wake of money-market reform and the general skittishness about interest rate risk given the current market environment.
Actively managed fixed-income ETFs may be garnering assets and be good for some more esoteric and illiquid markets, but that doesn’t mean passive ETFs can’t be used actively, says Matthew Bartolini, head of SPDR Americas research at State Street Global Advisors, which offers passive as well as actively managed fixed-income ETFs. There are ways to use passive fixed-income ETFs beyond simply using an ETF like AGG as a core product that doesn’t offer much yield.
With passive ETFs offering access to the global bond market, advisors can adjust for duration, currency risk, credit risk and other factors. “If you restructure these, even if you just equal-weight all the sectors, you’d get a better result than what AGG will give you,” he said.
Bartolini notes that when building portfolios, in addition to considering the return and risk assumptions, advisors need to think about their fee budget. Many of the actively managed fixed-income ETFs have higher expense ratios, with some topping over 100 basis points.
“If you’re willing to extend that fee budget and allocate to an active core manager who can essentially blend the interest rate and credit risk, while also managing the nuances of the macro uncertainty in this market environment, that’s something where an active fixed-income ETF can provide a [value],” he said.
Some actively managed ETFs are doing well because of the market cycle, Bartolini notes, like senior loans. Part of what’s worked in bond fund managers’ favor is that the market hasn’t seen a credit event since the global financial crisis 10 years ago, which has allowed them to pile on credit risk to boost performance, Johnson says.
That makes some advisors hesitant to use fixed-income ETFs—active or otherwise. Steven Wagner, co-founder of Omnia Family Wealth, says he’s concerned about underlying liquidity drying up if there’s a credit event, especially in more esoteric, lower-quality fixed-income ETFs.
Mauricio Gruener, co-founder and chief executive officer at GFG Capital—which uses actively managed fixed-income ETFs—says that with the changing fixed-income landscape with the Federal Reserve raising interest rates, “they make it a very attractive way to protect your investment.”
That could benefit an ETF like the Sit Rising Rate ETF (RISE), which is doing well after fees year-to-date and on a one-year basis, although it’s down slightly on a three-year basis.
Morningstar’s Johnson says the changing rate environment will make it more challenging for all bond ETFs, active or passive: “It’ll be more of a head wind for longer-duration bonds and less of a head wind for shorter-duration bonds.”