[Editor’s note: If you’d like to learn more about fixed income ETFs, join us Tuesday, Sept. 15, at 2:00 p.m. ET for our free webinar, “Why Active in Fixed Income Exchange-Traded Products?”]
The bond market is massive and it’s deep, but it’s certainly not immune to the gyrations a global pandemic triggers.
From unexpected action in certain fixed income segments, to new drivers of performance, to a rise in volatility, bond investors have felt firsthand the challenge of navigating this so-called unprecedented terrain that has been 2020.
In no way has this challenge kept investors at bay. That’s the good news.
Fixed income continues to be sought after for income, for total return, for diversification and for all-around opportunity. Net U.S. ETF asset creations in this asset class have surpassed $130 billion so far this year—far outpacing the asset haul seen in equity ETFs by roughly 2 to 1, and representing almost 50% of all net asset flows into ETFs year to date.
But this challenging year of firsts has raised the volume on an old, but lingering, question: Are fixed income ETF investors better served by active management?
Passive Bond ETF Investing Pros & Cons
This passive versus active debate is ages old, and it marches on without a clear winner. But in fixed income, it takes special resonance given the difficult access, lack of transparency and sheer deepness of the bond market.
In passive fixed income ETF investing, portfolios weighted by market value—or by most indebted at the top—are the norm, not the exception. The reliance on credit rating agencies, which some argue can be quite discretionary, is huge, and often goes unquestioned. Many index-based fixed income ETFs offer selective or optimized access at best because full replication of the bond market is just too difficult to achieve.
These are common traits of passive bond ETFs. They aren’t, however, bad traits necessarily. In fact, the biggest fixed income ETFs on the market today offer just that: broad, passive, liquid and cheap baskets of bonds many turn to in order to meet their income and diversification goals.
The iShares Core U.S. Aggregate Bond ETF (AGG) is an $80 billion fund today; the Vanguard Total Bond Market ETF (BND) has $61.5 billion in assets, offering a portfolio of more than 18,000 bonds for just 0.04%, or $4 per $10,000 invested.
As the most die-hard passive investors would say, bond investing isn’t supposed to be exciting, it’s meant to be boring. These funds offer that just fine.
What Active Managers Can Offer
But active management fans make a persuasive argument that in order to capitalize on opportunities created by the lack of transparency, by the difficulty in access, by market dislocations or unexpected action and/or intervention in bonds, a hands-on approach goes a long way.
It’s that kind of thinking—and that kind of investor sentiment about this asset class—that has fueled growth in a universe of fixed income ETFs that is increasingly actively managed. Today roughly a third of all fixed income ETFs have an active manager behind them.
So far, 2020 has offered ample opportunity to test that argument. Anyone paying attention to the bond market this year remembers when some bond ETFs suddenly dove into deep discounts to net asset value at the height of the market meltdown earlier this spring, just to jump into premium territory in reaction to an intervening Federal Reserve.
Fed’s Long Reach
Having the Fed a buyer of bonds, as well as bond ETFs for the very first time, changed the narrative in fixed income, and the market action with it. Few, if any, saw that coming before mid-March, and passive index investing, by design, is unable to nimbly adapt to this new driver in the market.
As credit spreads whipsawed in this new normal of Fed involvement, investors have been torn between the concerns about the survival rate of many of these companies due to the pandemic-driven economic slowdown, and the comfort of knowing the Fed is a backstop bond buyer. How do you assess true credit risk in this type of market?
Treasury investors haven’t had it any easier as the Fed, in its effort to keep markets liquid and humming amid the pandemic, committed to ultra-low rates for longer, while at the same time opening the door for higher inflation as it shifts its target policy. Lower rates mean lower income; higher inflation is positively correlated to yields. What are they to make of the outlook for this segment?
Bond investing may be meant to be boring, but it hasn’t been easy this year.
The team at Janus Henderson, including Nick Cherney, Jim Cielinski, John Kerschner and Nick Maroutsos, along with me, are going to tackle all of these issues challenging fixed income ETF investors this year in our upcoming webinar, “Why Active in Fixed Income Exchange-Traded Products?”
Whether it’s making sense of a challenging environment, understanding liquidity in times of trouble, positioning for where we currently sit in the cycle, or tactically finding income and total return in the many slices of a diverse bond market, we’re here for you. Bring your questions, and join us for a conversation you don’t want to miss.
Join us Tuesday, Sept. 15, at 2:00 p.m. ET. Register here. We look forward to seeing you there.
Contact Cinthia Murphy at [email protected]