The Benefits of Active Fixed Income ETFs for Advisors

Rate cuts by central banks in Europe, the U.S., and Canada have sparked renewed investor interest in fixed-income investments for 2024, but this time, its bond ETFs attracting the bulk of attention. Why?

Well, mainly because buying individual fixed-income securities isn't as intuitive as buying equities, mainly because bonds aren't traded on public exchanges. Modern day bond liquidity has significantly improved despite their over-the-counter nature, but on the whole, they remain a more complex asset class compared to equities and therefore more difficult to understand.

This setup creates challenges for retail investors and advisors alike, particularly when it comes to pricing transparency and liquidity, as finding a fair price and a ready buyer or seller in the secondary market can be difficult.

However, in 2024, there's no reason for anyone to struggle with these complexities. Active fixed income ETFs have transformed the way bonds are accessed, offering the same exposure in a more accessible, transparent, and liquid format. Here's why.

Transparency and visibility

Investors must consider various metrics to gauge the opportunities and risk of a bond, such as:

• credit ratings (which measures the risk that the bond issuer may default on its payments),
• yield to maturity (which represents the annualized rate of return an investor can expect to earn if they hold the bond until maturity),
• and duration (which measures the bond’s sensitivity to interest rate changes).

Bond ETFs provide exposure to 100s of bonds in one easy trade. The ETF offers regular, clear updates on key metrics, often presented on a publicly accessible webpage, making it easy for any investor to review.

For example, with the AXA IM’s Euro Credit PAB ETF exposure, the "portfolio analysis" section of the fund’s page clearly outlines the sectors and geographies the bond issues come from, and also provides a breakdown of their credit quality.

Source: Fund Homepage as of Sept. 3, 2024

Source: Fund Homepage as of Sept. 3, 2024

Source: Fund Homepage as of Sept. 3, 2024

This level of transparency makes it far easier for retail investors to assess their holdings and make informed decisions.

Diversification and liquidity

The greatest benefit of a bond ETF is the ability to easily size your position and enter or exit it just like you would when buying a stock.

You simply indicate the number of shares, select your order type (usually market or limit), and that’s it—no worrying about the complexities of bond auctions, navigating the OTC market, or trying to find a seller for a specific bond at the right price.

This convenience is especially important for high-yield "junk" bonds, which are typically less liquid than their investment-grade counterparts. With a bond ETF, professional management ensures that you have access to liquidity that might be hard to come by when trading individual high-yield bonds.

Additionally, if you're hunting for higher yields by venturing into lower credit quality bonds, the diversification provided by a high-yield bond ETF is crucial. In the event of a default, the impact on your portfolio is minimized compared to holding a single bond.

Distribution policy

Your average bond pays out interest semi-annually, leaving you with the decision of what to do with the coupon received. This can lead to extra friction from transactions or result in cash drag if the funds aren’t reinvested efficiently.

However, with the AXA IM’s Euro Credit PAB ETF exposure this concern is eliminated thanks to their accumulating structure, which focuses on total returns. These accumulating bond ETFs automatically reinvest any interest paid out by the underlying bond holdings back into the fund, managed seamlessly by the fund manager at no additional cost to you.

As a result, the net asset value (NAV) of both ETFs will reflect not only the price changes of the underlying bonds but also the reinvested distributions, allowing you to stay hands-off while maximizing your investment's growth.

Why go active?

You might think delegating all this to an active bond ETF would be costly, but that's not the case. For instance, the AXA IM’s US High Yield ETF exposure is actively managed, targets high-yield bonds, yet charges a reasonable portfolio fee of just 0.35%.

According to Statista, the average expense ratio for an actively managed bond mutual fund in the U.S. as of 2003 currently sits at 0.46%. In the UCITs market, examples like the AXA active bond ETFs mentioned earlier significantly undercut this. High fees, once a significant tailwind for active bond funds are now falling by the wayside and producing less drags on net returns.

In addition, the fixed-income markets remain one of the few areas where a disciplined active manager can have a better edge against passive strategies, This advantage arises from several characteristics unique to the bond markets.

Bond markets, particularly in less liquid segments, are less transparent than stock markets, which can lead to pricing inefficiencies. The OTC nature of bond trading means prices are negotiated rather than set on public exchanges, creating opportunities for skilled active managers to identify bonds that may be mispriced relative to their intrinsic value.

While increased transparency through electronic trading platforms and regulatory improvements have reduced some inefficiencies, active management can still add value, especially in less liquid or specialized bond markets).

Furthermore, the intricacies of bond pricing—driven by factors such as interest rates, credit risk, and maturity—requires a high level of expertise, particularly when assessing the fair value of bonds that are not frequently traded such as in the high-yield segment.

For example, despite six defaults in the U.S. high-yield market last year, the active approach used by the  AXA IM’s US High Yield ETF exposure resulted in zero defaults. This proactive strategy ensures that your investments are not only targeting higher returns but are also safeguarded against potential downturns.

Additionally, active management opens opportunities for integrating Paris Aligned Benchmark (PAB) standards. Beyond just pursuing alpha, or excess returns over the benchmark, fund managers can align investment decisions with environmental, social, and governance (ESG) criteria

Bond markets are also highly sensitive to economic fluctuations and central bank policies. Active managers can quickly adjust their portfolios in response to changes in economic indicators or shifts in interest rate policies, potentially enhancing returns or mitigating risks more effectively than a static, passive strategy.

Funny enough, support for the effectiveness of active management in bonds comes from the S&P Indices Versus Active (SPIVA) scorecard, which shows that in the "General Bond" (unconstrained) category, active bond fund underperformance of passive benchmarks over various periods remains relatively low compared to equities, with figures showing 31.25% for 1 year, 32.50% for 3 years, 45.45% for 5 years, 64.29% for 10 years, and 59.32% for 15 years.

These figures suggest that active strategies continue to hold an edge in the fixed-income space, likely due to the complex and dynamic nature of bond markets. This persistent anomaly, where passive strategies do not dominate as clearly as in equity markets, underscores the potential value of active management in fixed income investing.

Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.

Important information

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