According to the Index Industry Association’s annual ESG survey, 76% of respondents integrate ESG when running both passive and active fixed income mandates. This is a large jump from 42% in 2021. The survey, which was conducted with 300 asset managers, also found that 87% of passive asset managers are integrating ESG into their bond allocations. 85% of asset managers stated that ESG had become a higher priority over the past 12 months. Out of this figure, 43% said the concern around climate and corporate governance was the driving force behind that decision. Other reasons were a need for more diversified returns, regulatory and reputation risk, high energy prices, and geopolitical events. Almost a third cited a desire for increased returns. The biggest driver was their client’s knowledge of ESG, with 53% stating they were “very confident” in their clients' ESG knowledge.
Finsum: Asset managers are implementing ESG into fixed income allocations at a higher rate due to climate and corporate governance, diversified returns, higher energy prices, and client knowledge.
Research from Morningstar's annual Global Fund Flows found that actively managed fixed income funds saw $422 billion in outflows during the first half of the year. That figure accounted for 74% of all outflows from active portfolios. Active funds as a whole saw $568 billion in outflows, while index funds generated $432 billion in inflows. The net difference of $136 billion in outflows was the most since June to December of 2008, during the height of the Financial Crisis. The high percentage of active fixed income outflows is partly a result of the automatic rebalancing of model portfolios and target-date funds. Since equity returns have been more negative, automatic rebalancing has been triggering more trades to equity strategies to get allocations back in line. Passive fixed income funds saw $90 billion in inflows.
Finsum: Active fixed income funds accounted for 74% of all outflows from active portfolios during the first half of the year as automatic rebalancing favored equity strategies.
According to a paper published last month by Christopher Reilly of Boston College, corporate bond ETFs listed in the US, on average, pay 48 basis points a year in hidden costs that result from custom creation baskets. Since most fixed ETFs track thousands of individual bonds, custom creation baskets allow issuers and authorized participants to create a sample of the holdings which mirror the performance of the ETF. An authorized participant is an organization, typically a bank, that manages the creation and redemption of ETF shares in the primary market. Without sampling, the authorized participants would have to source every security. However, the custom ETF creation baskets allow authorized participants more flexibility to include securities that could significantly underperform the underlying index. This customization results in hidden costs that investors of ETFs could incur.
Finsum: Corporate bond ETFs are paying an average of 48 basis points a year in hidden costs resulting from customized creation baskets.
2022 has seen one of the most volatile six-month stresses that hasn’t included a full-blown economic collapse. With the U.S. recession looming, Fed tightening, surging inflation, and international conflict all still very much in play investors need a volatility strategy. Most investors’ loss aversion keeps them out of market gains and a negative bias, and a low volatility strategy can curb those fears while allowing participation. This is a factor-based approach to investment where a considerable factor can be on stocks with more stable price movements in comparison to the rest of the market. Typically this strategy favors older, medium to large companies, with stable performance. If markets take a large hit many of these bear less of the losses, but they still can capture the rallies during high volatility.
Finsum: A momentum factor strategy has the advantage in low-interest rate booms, but favoring stable price movements might beat markets in this environment.
The markets rally in response to the Fed’s latest tightening cycle, but it's the movement in combination with bonds that are potentially concerning. The longer end of the yield curve may not be realizing the extent of the Fed tightening with the 10-year rates falling in response. Analysts say this could be markets reading what they want from the Fed and not taking this phase of tightening seriously. This also could be the opposite, as the ten-two-year yield curve inverts, this could be the markets predicting a recession on the horizon, that is if the U.S. isn’t currently in one. Regardless, Powell made it completely clear that inflation is concern number one, and the Fed doesn’t believe the economy can function normally until inflation is tamed.
Finsum: There’s a possibility markets are happy there is a recession, because it could be the return to easy money and low rates.