Bonds: Total Market
Junk-bond ETFs showed a slight uptick, suggesting potential outperformance in 2024, especially under a soft-landing scenario for the US economy, according to Michael Arone of State Street Global Advisors.
While high-yield bonds may surprise investors with their resilience, concerns persist about the Fed's tightening and its impact on economic growth. Despite recent modest gains, ETFs tracking investment-grade bonds are still in the red for the year.
Investors remain cautious about high-yield spreads and potential widening, with some preferring rate risk over credit risk. Arone suggests a diversified approach, favoring short-term debt and bonds with intermediate durations.
Finsum: Duration management could be the key to weathering the storm in 2024.
BNP Paribas Asset Management has introduced a new ESG active fixed income ETF range, starting with the BNP Paribas Easy Sustainable EUR Corporate Bond and BNP Paribas Easy Sustainable EUR Government Bond ETFs. These ETFs aim to replicate benchmark performance while integrating sustainable principles using BNPP AM's ESG methodology and exclusion policies.
The firm's Head of Index & ETF Strategies highlighted the agility of this approach in responding to controversies and adapting to changing environmental factors, aligning with sustainability label criteria. BNP made a commitment in January to improving its offerings around ESG offerings and this new suite of investments will fall in line with those goals.
Lorraine Sereyjol-Garros, Global Head of Development for ETFs & Index Funds at BNPP AM, emphasized the importance of active ESG fixed income management in navigating the challenging market landscape, offering diversification and sustainable credentials in an affordable and convenient ETF structure.
Finsum: Active bond funds could be critical to navigating the landscape of 2024 as macro volatility is looming.
Buffered ETFs are a relatively new type of fund that offers a unique risk-management approach. These funds track an underlying index to replicate its performance while providing a "buffer" against significant losses. However, this protection comes at a cost, as the fund's upside is capped at a predetermined level.
As investor interest in buffered ETFs has grown, fund providers have diversified their offerings by tracking various indices and offering a range of buffer and cap levels. Several applications for these funds have also emerged, such as the ability to put cash to use that might otherwise be held out of the market.
Investors in or nearing retirement are particularly susceptible to market volatility, often resorting to holding cash to protect against short-term market fluctuations. While providing protection, this strategy also prevents them from participating in potential market growth.
Buffered ETFs bridge this gap, allowing investors to enjoy market gains up to the defined cap while safeguarding against substantial losses. With this level of protection built into the fund, investors may have more confidence to transition a portion of their portfolio out of cash and back into the market.
Finsum: Investors in or near retirement who fear market downside now have a place to invest that cash they have been holding on the sidelines: buffered ETFS.
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A major development in 2023 was the boom in active fixed income ETFs as measured by inflows and launches of new ETFs. Some reasons for interest in the category include opportunities for outperformance, lower volatility, and diversification. Ford O’Neil, fixed income portfolio manager at Fidelity Investments, sees structural reasons for the asset class’s recent success and believes it will continue.
According to O’Neil, there is more potential for outperformance in active fixed income vs equities, because indices only cover about half of the total bond market. In contrast, equity indices encompass a much larger share of the entire stock market. This means that the market will be less efficient, resulting in more undervalued securities.
Active managers are also able to better navigate the current landscape, where there is considerable uncertainty about the economy and monetary policy given more latitude when it comes to security selection. He notes that active fixed income ETFs have delivered strong outperformance vs passive fixed income ETFs over the last 8 years.
He stresses that identifying these opportunities is dependent on proper fundamental research and quantitative analysis followed by effective implementation. O’Neil is the co-manager of several active fixed income ETFs including the Fidelity Total Bond ETF (FBND) or the Fidelity High Yield Factor ETF (FDHY).
Recent economic data and tea leaves from Fed officials have resulted in more challenging conditions for fixed income. Essentially, there is much less certainty about the timing and direction of the Fed’s next move as economic data and inflation have been more robust than expected.
According to Michael Arone, chief investment strategist at State Street, this presents an opportunity with high-yield bonds given that yields are at attractive levels while a strong economy indicates that defaults will remain low. So far this year, high-yield bonds have outperformed with a slight positive return, while the iShares Core US Aggregate Bond ETF (AGG) and Vanguard Total Bond Market ETF (BND) are down YTD.
This is a contrarian trade as high-yield bond ETFs have had $387 million of outflows YTD, while fixed income ETFs have had $2.8 billion of net inflows YTD. It’s also a way for fixed income investors to bet that the US economy continues to defy skeptics and avoid a recession despite the Fed’s aggressive rate hikes.
Currently, high-yield bonds have an average spread of 338 basis points vs Treasuries. Many of the most popular high-yield ETFs have effective durations between 3 and 4 years which means there is less rate risk. Spreads have remained relatively tight and could widen in the event of the economy slowing.
Finsum: High-yield ETFs are offering an interesting opportunity given attractive yields. This segment of the fixed income market also is benefiting from recently strong economic data which indicates that default rates will remain low.
Fixed income investors have had to deal with considerable volatility over the past couple of years. The asset class has provided investors with generous yields between but has not lived up to its potential in terms of moderating portfolio volatility and serving as a counterweight to equities.
In the near term, this volatility is likely to persist especially given uncertainty about the economy and interest rates. Due to these circumstances, fixed income investors should consider actively managed ETFs which are better equipped to navigate these conditions. Active managers are able to optimize holdings and take advantage of opportunities that are unavailable to passive managers.
Not surprisingly, active bond funds have outperformed since 2022 when interest rate volatility started spiking. Yet, many advisors have been slow to embrace active fixed income ETFs. Some have stuck to actively managed mutual funds instead. According to Capital Group, 80% of assets in fixed income mutual funds are actively managed, while only 12% of assets in fixed income ETFs are actively managed.
Actively managed ETFs offer advantages such as lower costs, more liquidity, and tax advantages. Capital Group attributes slow adoption to a lack of awareness of the benefits of active fixed income ETFs and limited supply among advisors. To this end, it’s investing in educating advisors about why they should consider actively managed fixed income ETFs over other options.
Finsum: Active fixed income ETFs have many advantages over passive fixed income ETFs and actively managed fixed income mutual funds especially in the current environment. Yet, adoption has been slow for a few reasons.