Active Bonds, Emerging Markets: Big 2024 Themes

Active Bonds, Emerging Markets: Big 2024 Themes

Country-specific funds and active bond ETFs are seen as trending in 2024.

Reviewed by: Staff
Edited by: Lou Carlozo

The ETF industry in the U.S. experienced a strong 2023, setting a calendar record for new launches. Although inflows were lower than anticipated as investors rotated into money market funds, they will likely finish the year at close to a robust $500 million. Given this context, what ETF trends will emerge next year? In this two-part series, we outline four to watch.

Trend 1: The “Unbundling” of Emerging Markets Exposure

For many years, ETF investors have accessed emerging markets via broad ETFs such as the iShares Core MSCI Emerging Markets ETF (IEMG). As of Dec. 8, 2023, the four largest emerging market ETFs accounted for 58% of all assets in equity-based EM exposure in the U.S. All four provide diversified exposure across countries, highlighting how broad ETFs have historically served as the vehicle of choice for U.S. investors to access emerging markets. But looking ahead to 2024, we may see this change as investors opt for a more nuanced approach via more targeted regional and country-specific funds.

Significant exposure to China in traditional emerging market ETFs could drive this change. Figure 1 highlights how China exposure in these ETFs ranges from roughly 25%-30%. The Vanguard FTSE Emerging Markets ETF (VWO) had a 31% allocation to China as of the end of October 2023. IEMG and the Schwab Emerging Markets Equity ETF (SCHE) had 24.4% and 32.6% allocations to China, respectively, as of Dec. 8, 2023.

Figure 1: Fund Exposure by Country for Key Emerging Market Equity ETFs

Figure 1

Source: CFRA ETF Database; IEMG, SCHE: as of December 8, 2023; VWO: as of October 31, 2023.

This large China weighting reflects this emerging market’s its status as the largest and most important. Additionally, China’s weight in many emerging market ETFs increased after MSCI (a leading index provider for ex-U.S. equity exposure) began to phase China “A” shares into their indices starting in 2018. Yet having such a high exposure to China in their primary emerging market holdings challenged ETF investors in 2023. 

As seen in Figure 2, China significantly underperformed ex-China emerging markets this year. The SPDR S&P China ETF (GXC) was down 15.6% year to date through Dec. 12, 2023, while the iShares MSCI Emerging Markets ex China ETF (EMXC) was up 11.4% during the same period.

Figure 2: Relative Performance of China vs. EM Ex-China ETFs

Figure 2

Source: CFRA ETF Database; Data as of December 11, 2023.

A slower-than-anticipated post-Covid reopening drove China’s underperformance, as well as weakness in the country’s property sector. Longer-term issues such as global firms diversifying their supply chains to other Asian countries and geo-political tensions with the U.S. could also impact the nation. If China continues to underperform in 2024, investors may decide to “unbundle” their EM exposure.

Investors could choose to calibrate their exposure by combining Emerging Market Ex-China ETFs such as EMXC or Columbia EM Core ex-China ETF (XCEM) with China-focused ETFs. These ETFs have already taken in substantial flows in 2023 (see Table 1). Alternatively, investors could construct the EM sleeve of their portfolios with country-specific ETFs. A third option would be to use active ETFs such as the KraneShares Dynamic Emerging Markets Strategy ETF (KEM), as the fund’s China exposure is dynamically adjusted based on fundamental, valuation and technical signals. We expect investors may increasingly adopt some of these strategies for their EM exposure in 2024.

Table 1: Largest Emerging Market Ex-China ETFs Listed in the U.S.

Table 1

Source: CFRA ETF Database; Data as of Dec. 14, 2023.

Trend 2: Increased Flows and Competition in the Active Bond ETF Category

When viewed in aggregate, indexing dominates the bond ETF space in the U.S., with active ETFs only accounting for 11% of assets as of Dec. 8. Of the 20 largest bond ETFs in the U.S., only one, the JPMorgan Ultra-Short Income ETF (JPST), is actively managed. However, a closer look reveals active management is gaining traction in the core bond ETF category. 

As Figure 3 illustrates, active ETFs now account for 24% of broad bond ETF assets in the U.S., relative to just a 3% and 4% share for active in the treasury and corporate bond ETF segments respectively. This year through Dec. 8, actively managed ETFs have taken in almost a third of net inflows into core, broad market bond ETFs.

Figure 3: Share of Active Management in the U.S. by Bond ETF Type

Figure 3

Source: CFRA ETF Database; Data as of December 8, 2023.

This growth in active management and the possible saturation of indexing within the core bond ETF category may have played a role in Vanguard’s recent product expansion. On Dec. 7, it launched the actively managed Vanguard Core Plus Bond ETF (VPLS) and announced plans to launch the Vanguard Core Bond ETF (VCRB) before the end of 2023. These products will complement the Vanguard Ultra-Short Bond ETF (VUSB), the firm’s only other actively managed bond ETF, which has already exceeded $4 billion in net assets.

VPLS is priced at an expense ratio of 0.2%, lower than most of the largest ETFs in the active core bond ETF category (see Table 2).

Table 2: Largest Active Domestic Broad Bond ETFs Listed in the U.S.

Table 2

Source: CFRA ETF Database. Data as of Dec. 14, 2023.

The low fee for VPLS is likely to bring investor attention as well as provide higher flows and downward fee pressure to this category. Interestingly, the firms that dominate the indexed and active bond ETF categories are quite different. In the indexed bond space, Vanguard competes with its traditional rivals, BlackRock and State Street. 

In the active bond space where it is now expanding its footprint, Vanguard will compete with JPMorgan, First Trust, and PIMCO (see Table 3). This competition will put pressure on the incumbent players but benefit investors and provide an important trend to watch in the next year.

Table 3: Largest U.S. Bond ETF Issuer by Market Share – Active vs. Indexed

Table 3

Source: CFRA ETF Database. Data as of Dec. 8, 2023.

Aniket Ullal heads CFRA’s ETF data and analytics business. He has worked in the ETF industry since early in its development. Ullal founded First Bridge, one of the industry’s leading ETF data sets that was acquired by CFRA in 2019. Previously, he was the product head for U.S. index products at S&P Dow Jones Indices.