Bonds: Total Market

Fidelity Investments recently announced it was adding to its active fixed-income strategies lineup with the launch of the Fidelity Municipal Core Plus Bond Fund (FMBAX). According to Fidelity, FMBAX is available commission-free and with no investment minimum to individual investors and financial advisors through Fidelity’s online brokerage platforms. The fund has a 0.37% net expense ratio and a 1.28% gross expense ratio. FMBAX is measured against the Bloomberg Municipal Bond Index and the Fidelity Municipal Core Plus Bond Composite Index, and aims to provide a high current yield exempt from federal income taxes, and may also consider capital growth. Co-managers Cormac Cullen, Michael Maka, and Elizah McLaughlin will analyze the credit quality of the issuer, security-specific features, current and potential future valuation, and trading opportunities to select investments. The fund launch comes at a time when the retail and institutional demand for higher-yielding municipal bond funds is growing. According to the fund giant, this new product seeks to offer a strong yield and total return profile, with potentially lower volatility than pure high-yield funds. Jamie Pagliocco, Fidelity’s fixed income head has this to say about the fund launch, “Fidelity’s growing suite of active fixed income investment products leverage Fidelity’s breadth and depth of resources and expertise as an active manager to identify investment opportunities across the credit spectrum.”

Finsum:Fidelity Investments launched an active municipal bond mutual fund amid increased retail and institutional demand for higher-yielding municipal bond funds.

While fixed-income ETFs are seeing strong inflows this year, academics from a trio of U.S. business schools suggest fixed-income ETFs can suck the liquidity out of corporate bonds during times of market stress. According to them, the potential problem stems from the creation and redemption baskets that ETF issuers trade with market makers, known as authorized participants (APs), to handle inflows or outflows from their ETFs. Unlike equity ETFs, bond funds’ creation and redemption baskets typically do not include every bond in the index they are tracking as this could include hundreds or even thousands of separate issues. In their paper, Steering a Ship in Illiquid Waters: Active Management of Passive Funds, the academics argue that in normal times a bond’s inclusion in an ETF basket makes the bond more liquid. This is due to a random mix of creations and redemptions increasing trading activity. But, during a crisis, when many investors are running for the exits, redemptions hugely outweigh creations. When that happens, if a bond is included in the basket, the APs “may then become reluctant to purchase more of the same bonds, reducing their liquidity,” according to the paper. However, other bond strategists disagree, including Dan Izzo, chief executive of GHCO, an ETF market maker. Izzo, who argues that the rise of ETFs had actually increased liquidity during periods of market stress, stated that “The causality ran in the opposite direction — it is because some bonds are illiquid that they increasingly feature in redemption baskets as sell-offs intensify, not vice versa.”

Finsum:While fixed-income ETFs continue to see strong inflows, a trio of academics argues that bond funds make the market less liquid during periods of stress.

As investors increasingly buy ESG funds, there has also been an increase in academic research on the impact of implementing ESG constraints on equity portfolios. However, there hasn't been as much attention paid to research on ESG fixed-income investing. Inna Zorina and Lux Corlett-Roy published their study “The Hunt for Alpha in ESG Fixed Income: Fund Evidence from Around the World,” in the Fall 2022 issue of The Journal of Impact and ESG Investing. In the study, they examined whether ESG fixed-income funds generate out- or under-performance after controlling for systematic fixed-income factors. They found that while ESG fixed-income funds with a higher level of risk generally produced higher returns, most ESG fixed-income funds did not produce statistically significant positive or negative gross alphas. In fact, only 7% of funds managed to deliver greater returns at a lower level of risk relative to the respective benchmark. The study revealed that across ESG fixed-income funds with a European, U.S., and global focus, performance was mainly driven by systematic fixed-income factor exposures such as term and default risk. The results led Zorina and Corlett-Roy to conclude: “ESG fixed-income mutual funds and ETFs have not consistently delivered statistically significant gross alpha controlling for key fixed-income factors. The majority of alphas are statistically insignificant and therefore indistinguishable from zero. This conclusion is similar across fixed-income funds with a European, US, and Global ESG investment focus.”

Finsum:A recent study that looked into whether fixed-income ESG funds provided outperformance revealed that ESG fixed-income mutual funds and ETFs have not consistently delivered statistically significant gross alpha.

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