[This article appears in our October 2017 issue of ETFR Report.]
It’s right there in the name. Nine times out of 10 in this business, we don’t talk about bonds—the thing we actually invest in. We talk about the desired outcome: a fixed, knowable source of income.
The invention of the mutual fund changed everything when it came to financial planning, and ETFs have only made mutual funds better, cheaper and more transparent. But one thing went by the wayside—the certainty of owning individual bonds. No bond ETF delivers a truly stable pattern of returns, unless it’s investing so far down the duration curve as to provide precious little actual yield.
Yet we still pool all of these disparate approaches to investing in debt—from emerging market local currency sovereigns to junk bonds to 30-day U.S. government-backed bills—in one big bucket and slap a label on it that’s actually incorrect.
To make matters worse, most bond ETFs track traditional bond indexes that often don’t make much intuitive sense. If your loser brother who’s always borrowing money asks you for another $100 at Thanksgiving, you’re far less likely to say yes than when your risk-averse, straight-and-narrow sister asks. Yet traditional bond indexes load up on the issuers who owe the most money—they’re dominated by the loser brothers of the world.
An Active Solution?
Actively managed ETFs—like the famous PIMCO Active Bond ETF (BOND) or the SPDR DoubleLine Total Return Tactical ETF (TOTL)—are one answer to this problem, but in a sense, they’re a bit of a cop-out. It’s almost like academic finance nerds have tossed aside their slide rules and said, “I dunno, maybe Jeff Gundlach can figure it out,” rather than really reinventing the fixed-income index.
As an advisor, it’s even harder to know how to handle. Client retirees who used to count on the safety and security of clipping coupons from blue chip bond issuers now have to wade into the unknown waters of bank loans and MLPs and emerging dividend stocks to get the kinds of yields needed to truly live off a carefully accumulated nest egg.
If all this sounds negative, I choose to see it as an opportunity. With over 6,000 ETFs globally and over 2,000 just in the U.S., it’s easy to wonder if there’s any room left for new ideas. My fervent hope is that the answer is “yes,” and that we see it in this over-broad bucket of “fixed income.”
The world doesn’t need another investment-grade bond fund or a new spin on owning developed-market sovereign debt. What the world needs is real solutions for people who are in the drawdown portion of their investment life.
This issue of ETF Report outlines some ways in which the market is evolving to meet this demand, but it’s not enough.
For the firms that figure it out—that truly innovate in the “fixed income” market—the rewards will be great, and investors will be thankful.