Despite the potential advantages offered by active fixed income strategies, the vast majority of these flows have made their way into passive fixed income ETFs. While there is growing interest in active management, with 30% of ETF buyers seeing value in using active ETFs for fixed income investing according to the 2023 Trackinsight Global ETF survey, several misconceptions appear to be holding investors back from going active. Here, we address the four key questions that investors should ask when selecting ETFs for their fixed income exposure.
Optimising fixed income allocation
Whether your portfolio allocation to fixed income is fulfilling its intended role may depend on the chosen index and whether you choose an active or passive approach.
Passive strategies, which aim to closely track bond indices while minimising costs, remain hugely popular with investors. However, cap-weighted bond indices have some well-documented limitations. First, they give the greatest weight to issuers with the greatest amount of debt. So passive funds will – by default – be more concentrated in the most indebted issuers, not necessarily the most solvent.
Second, passive funds have no room for manoeuvre as the index composition changes. For example, over the last decade, the credit quality of the investment grade corporate bond market has deteriorated. As companies have taken advantage of historically low interest rates to borrow more through the debt markets, the amount of investment grade corporate debt outstanding has grown and credit ratings have dropped. While passive ETFs reflect the credit and interest rate risk of the underlying index, active strategies, by contrast, have the ability to focus on the most attractive issuers based on rigorous credit research.
Fixed income index tracking
Tracking fixed income indices is not an easy task. Take the Bloomberg Global Aggregate Bond Index, for example. This index was launched in 1990 and is composed of government, government-related and corporate bonds, as well as asset-backed, mortgage-backed and commercial mortgage-backed securities from both developed and emerging market issuers. With over 29,000 constituents from 4,554 issuers across 28 local currency markets, it is one of the largest indices globally by constituents.
Only a handful of ETF providers offer passive ETFs tracking the Global Aggregate Bond index. None of these passive ETFs include the full list of constituents, since it is too complex and expensive to include nearly 30,000 bonds. Some only contain around 10,000 bonds. Even though these ETFs are labelled as passive, the ETF providers still need to take active investment decisions on which bonds to include – but the decisions are made on the basis of ensuring a low tracking error rather than from a risk management or alpha generation perspective, as is the case with active ETFs.
How liquid is my fixed income ETF exposure?
A common misconception is that active fixed income ETFs might be less liquid than passive ETFs. In reality, there is no reason why this should be the case. Whether active or passive, most fixed income ETFs will employ sampling methodologies to gain exposure to the market, with client dealing desks having several options to execute their ETF flow. As a result, to understand an ETF’s liquidity, investors should consider its trading lifecycle. For example, how mature is the ETF and what is its size in terms of its assets under management? How much of the ETF’s volume trades on and off exchange, and how liquid are the underlying bonds? And how likely is my order going to result in a primary market creation or redemption?
Whether active or passive, investors should also look for fixed income ETFs that are backed by a dedicated capital markets team with a strong technology platform and strong relationships with a diversified set of authorised participants (APs). The ETF provider must be able to demonstrate that they can provide APs with all the information they need to deliver efficient pricing of the ETF at all times, while utilising both primary and secondary markets to boost liquidity. If this is the case, trading active ETFs, in terms of liquidity and price, is no different to passive ETFs.
How can I find the right active ETF issuer?
The active fixed income UCITS ETF market is continuing to innovate and is very much in the growth stage in terms of offering a new and diverse set of solutions to all client types. While passive ETFs and active mutual funds have had a head start, in the last 12 months a wave of new active fixed income UCITS ETF solutions has hit the market. Currently, there are 33 active UCITS fixed income ETFs available, offering multiple share class types including currency hedged options.
Similar to selecting the right bond index when looking at passive ETFs, when selecting an active ETF provider it is important to look closely at the underlying strategy itself. The capabilities and resources of the ETF provider are also crucial. Given that active ETFs are driven by research, an active ETF provider should ideally have a global network of analysts and portfolio managers providing portfolio managers with the insights required to select the most attractive opportunities.
Why invest into active fixed income ETFs?
Active fixed income ETFs by J.P. Morgan Asset Management
J.P. Morgan ETFs are rigorously designed to push the boundaries of ETF investing so that investors can build diversified, competitively priced portfolios. When it comes to fixed income investing, J.P. Morgan’s time-tested, globally integrated investment processes bring intensive research, diverse talents and rigorous risk management to your portfolio, providing access to deep resources and specialised expertise to successfully navigate today’s complex bond markets. Whether you’re seeking yield, total return or stability, J.P. Morgan Asset Management is the largest active UCITS ETF provider, offering nine active fixed income ETFs across the global aggregate, credit, high yield, green, social and sustainable, and ultra short income bond markets.