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Active Fixed Income ETFs Growing as Investors Navigate Bond Market Uncertainty

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What You Need to Know

  • Many advisors are finding these ETFs are effective in balancing interest rate and credit risk, while helping clients generate income.
  • To meet clients’ need for income and returns, advisors face a dilemma: Add interest rate risk, or add credit risk to a portfolio.
  • Advisors may opt to take losses in fixed income and rebalance portfolios with a tilt toward actively managed bond ETFs.

Despite the heightened uncertainty about interest rates and inflation as we get closer to year-end, investor appetite for fixed income ETFs hasn’t waned — especially for actively managed fixed income ETFs.

Many advisors are finding actively managed fixed income ETFs are an effective way to balance interest rate and credit risk, while helping their clients generate income, and keep more of what they own. 

Taking a look at the genesis of active fixed income ETFs, we see that while worries over higher inflation and interest rates have been a recent factor driving growth, the category has been quietly growing since the first active fixed income ETF was launched in 2008. By 2011, there were still just 25 active fixed income ETFs, with assets of just $3 billion. Today, there are over 175 active bond ETFs with $137 billion in assets. 

One of the most common questions we hear from financial advisors is: How do I navigate today’s challenging fixed income environment? And according to a recent survey conducted by State Street Global Advisors, about half of investors expect to pay for advice on how to generate income out of their various sources of retirement savings. With historically low yields and historically high interest rate risk, advising clients on decisions related to fixed income portfolios is increasingly difficult. 

To meet clients’ need for income (and returns), advisors are faced with two imperfect decisions: Take on additional interest rate risk, or add credit risk to a portfolio. Either choice exposes clients, especially for those living on fixed incomes, to added risk that could push them out of their comfort zone. These challenges continue to grow as the Federal Reserve talks about tapering its bond purchases and potentially putting upward pressure on rates.

At the same time, prudent advisors recognize the need for bonds to remain a core portion of many client portfolios to hedge against the risk of stock market volatility, especially as valuations are extended.

Given these challenging market dynamics, advisors are embracing active management in the fixed income space to help make their portfolios more resilient, and their investment vehicle of choice is increasingly an ETF.

Financial advisors are realizing that ETFs are no longer only about gaining passive beta exposure. On the contrary, active ETFs provide investors exposure to bond managers with experience managing complex bond portfolios in a variety of market environments. This is especially important today, considering the direction for interest rates remains uncertain as inflation risk picks up.

Cost is another key consideration that’s shaping portfolio holdings. While investors are embracing actively managed fixed income ETFs for their transparency, liquidity and flexibility, they’re also attracted to their low fees. The median net expense ratio for an actively managed fixed income ETF is 0.39%, which is significantly lower than actively managed fixed income mutual funds (0.65%).

As we approach year-end, a time when many investors harvest tax losses, 2021 may be ripe for some to take losses in fixed income. A recent analysis by our SPDR Research team found that approximately four out of every five fixed income ETFs have year-to-date price losses. 

This performance coupled with the potential for tax increases in the not-too-distant future make it even more paramount for investors to look for losses wherever they may be in a portfolio. Specifically, advisors may want to use this opportunity to take losses in fixed income and rebalance portfolios with a tilt toward actively managed bond ETFs. 

Looking ahead, we expect to see continued demand for actively managed fixed income ETFs, as many advisors remain concerned about balancing the income objectives of their clients with the sizable interest rate risk in the market. The low-rate environment is also likely to continue to support the growth of active fixed income ETFs, as investors seek to keep more of what they earn. Active approaches may be able to meet this need, with an ability to rotate among higher yielding market sectors while also managing overall portfolio risk. 

Allison Bonds is head of private wealth management at State Street Global Advisors.