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
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.
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.