Rethinking fixed income ETFs
Investor interest in fixed income exchange-traded funds (ETFs) has remained high. According to Trackinsight’s Global ETF Survey 20231, 40% of respondents are planning to increase their fixed income allocation through ETFs over the next 2-3 years.
Although the growth in fixed income ETFs is largely driven by passive strategies, they don’t necessarily create the outcomes some investors expect from such allocations including diversification, hedging against the effects of rate volatility and generating income opportunities2. Passive investors are also vulnerable to the changing investment characteristics of fixed income indices and could miss out on exposure to securities and sectors that are not represented in a given index.
We believe the dynamic is changing for fixed income ETFs - the flexibility to make active decisions3 is becoming critical in the current interest rate environment.
Greater diversification across fixed income
Generally, bond indices are less reflective of the markets they seek to emulate2. The Bloomberg U.S. Aggregate Bond Index (the Agg), the benchmark for investment-grade bonds, captures only 49% of the US bond market4, as illustrated.
The Agg remains highly concentrated in US Treasury and agency mortgage-backed securities5, which represent about 70% of its underlying assets6. The index’s rule-based construction, designed in the 1980s, excludes some securities that some investors may prefer to deploy in a modern, diversified portfolio: certain agency mortgage securities, asset-backed securities (ABS) and about 40% of all corporate bonds.
The Agg excludes large parts of the US bond market
4. Source: Bloomberg, J.P. Morgan Asset Management; data as of 31.12.2021. Data represents Bloomberg U.S. Aggregate Bond Index.
Investors looking for broader market diversification would need to seek exposure to a more complete set of opportunities – and access to sectors such as ABS, high-yield bonds7 and emerging market debt – to help generate income opportunities and return potential.
Ability to make active decisions
Since a passively-managed strategy is designed to track an index, there is no opportunity to make active decisions, such as making tactical allocations as well as managing duration and risk8, 9.
As rates rise, investment managers have the flexibility to lower duration versus the Agg to manage declining bond prices. Depending on the particular strategy’s objective, active managers may have the flexibility to upgrade credit quality, increase liquidity profile and capture yield by allocating to other sectors of the fixed income market.
Additionally, active fixed income ETFs can provide enhanced access to liquidity. ETFs trade in the secondary market, giving investors the ability to buy and sell throughout the day. The diversity of the investor base for active fixed income ETFs also supports the liquidity of the product: not all owners of an ETF are sellers at the same time. Read more >
The unique mechanics of ETFs have the potential to change the delivery of active fixed income strategies. Amid rising rates in conjunction with increased market volatility globally, active, flexible decision-making is critical to portfolio performance in a changing economic environment.
Conclusion
With some fixed income investors increasingly adopting ETFs, J.P. Morgan Asset Management’s suite of research-driven, actively managed fixed income ETFs can help them navigate risk and enhance return opportunities while building stronger portfolios.
Provided for information only based on market conditions as of date of publication, not to be construed as offer, research, investment recommendation or advice. Forecasts, projections and other forward looking statements are based upon current beliefs and expectations, may or may not come to pass. They are for illustrative purposes only and serve as an indication of what may occur. Given the inherent uncertainties and risks associated with forecast, projections or other forward statements, actual events, results or performance may differ materially from those reflected or contemplated.
Diversification does not guarantee investment return and does not eliminate the risk of loss. Risk management does not imply elimination of risks.
1. Source: “Global ETF Survey 2023”, Trackinsight, as of May 2023.
2. Source: “Active fixed income in an ETF wrapper”, 02.05.2023.
3. For illustrative purposes only based on current market conditions, subject to change from time to time, and are not to be construed as offer, research or investment advice. Not all investments are suitable for all investors. Exact allocation of portfolio depends on each individual’s circumstance and market conditions.
5. Securitisation is the process in which certain type of assets, such as mortgages or other types of loans, are pooled so that they can be repackaged into interest-bearing securities. Examples of securitised debt include asset-backed securities and mortgage-backed securities
6. The Bloomberg U.S. Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, fixed-rate agency MBS, ABS and CMBS (agency and non-agency). Provided the necessary inclusion rules are met, US Aggregate-eligible securities also contribute to the multi-currency Global Aggregate Index and the US Universal Index. The US Aggregate Index was created in 1986, with history backfilled to 01.01.1976.
7. High-yield credit refers to corporate bonds which are given ratings below investment grade and are deemed to have a higher risk of default. Investments in below investment grade or unrated debt securities, may be subject to higher liquidity risks and credit risks comparing with investment grade bonds, with an increased risk of loss of investment. Yield is not guaranteed. Positive yield does not imply positive return.
8. Duration is a measure of the sensitivity of the price (the value of the principal) of a fixed income investment to a change in interest rates and is expressed as number of years.
9. Risk management does not imply elimination of risks.
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