Displaying items by tag: active etfs

Active fixed income ETFs are seeing strong inflows and a slew of new launches to capitalize on its increasing popularity. Some major drivers of demand are growing awareness and comfort from advisors and institutions, elevated yields, and outperformance on longer timeframes.

In addition to these secular drivers of demand, the asset class is benefitting from the current uncertainty around the economy and Fed policy. Active managers have more discretion in terms of duration and quality when selecting securities. This creates more alpha especially in a sideways market. 

The latest entrant in the active fixed income ETF space is Madison Investments which just launched the Madison Aggregate Bond ETF which invests in all types of bonds to generate superior long-term risk-adjusted performance. It believes that the fund will have lower risk than benchmarks in addition to income through risk-conscious investing. 

The ETF has an expense ratio of 0.40% and marks its third ETF launch and first fixed income ETF. It will be co-managed by Mike Sanders, the Head of Fixed Income, and Allen Olson, Portfolio Manager. The fund will hold between 100 and 500 securities with up to 10% in non-investment grade credit. Currently, it has an average duration of 6.3 years.

Finsum: Madison Investments launched the Madison Aggregate Bond ETF which is an active ETF that aims to have lower risk than benchmarks. 

Active fixed income has underperformed for the last 4 quarters due to the sharp increase in rates and tightening of spreads. However, the asset class could be poised to outperform as the Fed pauses and offers the best way for investors to take advantage of higher yields according to Sage Advisors Chief Investment Officer Rob Williams. 

Williams sees the Fed’s current rate path as being data dependent. This period could last for several quarters and offers specific advantages for active fixed income given its ability to tap a wider variety of duration, sectors, and risk to generate alpha. 

Eventually, Williams sees the yield curve steepening as the Fed inevitably shifts from ‘pausing’ to cutting. This process is likely to be volatile given the underlying resilience of the economy and labor market, and active fixed income tends to outperform in volatile markets.  

Active managers also have the ability to identify value in the fixed income space to improve return and risk factors. Due to volatility compressing in 2023, spreads have also tightened as well. This means that security selection has a more meaningful impact on returns and risk. 

Finsum: Active fixed income offers specific advantages to investors that are especially relevant if the Fed is pausing rate hikes and remaining ‘data-dependent’. 

A major theme of 2023 has been the constant compression in volatility. In fact, the volatility index (VIX) is now lower than when the bear market began in January of 2022 despite the S&P 500 being about 10% below its all-time highs.

However, the consensus continues to be that these conditions won’t persist for too long. The longer that rates remain elevated at these lofty levels, the higher the odds that something breaks, causing a cascade of issues that will lead to a spike in volatility and a probable recession. According to Vanguard, a shallow recession remains likely to occur sometime early next year. 

For fixed income, it will certainly be challenging. So far this year, the asset class has eked out a small gain despite rates trending higher due to credit spreads tightening and low default rates. However, more volatility is likely if rates keep moving higher which would likely lead to selling pressure or if inflation does cool which would result in the Fed loosening policy, creating a generous tailwind for the asset class.

Given this challenging environment, active fixed income is likely to outperform passive fixed income as managers have greater discretion to invest in the short-end of the curve to take advantage of higher yields while being insulated from uncertainty. Additionally, these managers can find opportunities in more obscure parts of the market in terms of duration or credit quality. 

Finsum: Fixed income has eked out a small gain this year. But, the environment is likely to get even more challenging which is why active fixed income is likely to generate better returns than passive fixed income.

In a strategy note, Scott Solomon and Quentin Fitzsimmons, the portfolio managers of the Dynamic Global Bond Fund, discuss why active fixed income is the best asset class for the current market environment. Despite recent economic data which indicates that inflation and the economy are both more resilient than previously expected, the pair believe that we are in the midst of a shift from one monetary regime to another.

However, they acknowledge that this is not going to be a smooth process. In fact, they expect a bumpy process especially given investor positioning. But, this uncertainty is what they believe will create opportunities in terms of credit quality and duration. Of course, such opportunities can be taken advantage of better by active fixed income managers rather than passive funds which are tracking benchmarks and unable to invest in securities of varying quality and duration.

Soloman and Fitzsimmons see a new ‘normal’ and expect rates to be structurally higher over the next couple of decades given high levels of debt to GDP in developed countries all over the world. Additionally, they anticipate that the negative correlation between stocks and bonds which prevailed in the years between the 2008 financial crisis and the pandemic is unlikely to return as long as central banks are not actively supporting markets. 

Finsum: Scott Solomon and Quentin Fitzsimmons of T. Rowe Price’s Dynamic Global Bond Fund shared their thinking about why they expect active fixed income to offer the best opportunities in the coming years.

In 2022, active ETFs accounted for 15% of total global inflows into ETFs. In 2023, active ETFs now account for 25% of total inflows. 

Is this a temporary blip due to the current environment of economic uncertainty and high rates and inflation? Or, is this a new trend that we should expect to continue for the foreseeable future.

In a recent report, State Street supports the latter argument. The asset manager sees recent regulatory reform as a major catalyst for growth in the active sector. Rule 6c-11 modernized the process to launch ETF, shortening the runway from many years to 60 days. This has resulted in an explosion of ETF offerings. In the last 3 years, 750 active ETFs have been created, while only 325 were created in the 11 years prior to Rule 6c-11. 

Another regulatory change is that ETF providers are able to be slightly less transparent with their holdings. This has led many managers to launch their own ETFs who were previously concerned about giving their best ideas for free. And, it’s also led many mutual funds to also offer active ETFs with similar strategies. 

It’s particularly bullish on active fixed income ETFs as it sees more room for innovation in the space. And, it notes that many advisors and institutions are just becoming familiar with the asset class.

Finsum: Active fixed income and equity ETFs are seeing incredible growth over the last couple of years due to a combination of regulatory changes and innovation.