The Evolution and Revolution of Active Fixed-Income ETFs

Shayan Hussain

The fixed-income market is undergoing a seismic shift, as active fixed-income exchange-traded funds  gain prominence in the investment community. These investment vehicles offer investors differentiated bond strategies inside the dynamism of the ETF structure, which is particularly adept at helping investors navigate times like these—namely, those with elevated economic uncertainty and market volatility. In our view, the rise of active fixed-income ETFs is not just an evolution; it’s a revolution capable of transforming how investors allocate capital.

Fixed Income: A Market Built for Active Management

Jon Maier

Comprised of about 3 million unique securities globally, the fixed-income market is large and ripe with opportunity. Accessing this complex market’s most attractive relative value opportunities, however, requires knowhow. Passive fixed-income indices have their merits, but they are limited in their composition. The benchmark Bloomberg Aggregate Index reflects roughly half of the exposure of the U.S. bond market. By contrast, active managers have the ability to move beyond the constraints of the benchmark to find the most attractive opportunities. Managers with flexibility can source bonds in less trafficked areas to pick up additional yield while managing for downside protection.

That flexibility is key when considering that investing in fixed income requires investors to account for numerous variables, including interest rate sensitivity, credit risk, structural market inefficiencies, concentrated exposures in portfolios to the most indebted issuers and liquidity. Whereas passive fixed-income strategies absorb the challenges these variables present, active managers have the freedom to adjust to them.

Active ETFs: A Dynamic Fixed-Income Solution

In 2019, the Securities and Exchange Commission modernized regulations for ETFs, reducing barriers to market entry and promoting more competition and innovation under a more consistent framework. That mix effectively catalyzed the ETF industry’s rapid growth. Prior to what’s commonly known as the ETF Rule, the ETF universe consisted of approximately 1,700 ETFs. Since then, roughly 70% of launched—bringing the total to about 4,000 ETFs—have been actively managed.

This growth extends to fixed-income ETFs. Before the ETF Rule’s implementation, the global fixed-income ETF market was valued at $1.1 billion. Today, it has grown to $2.7 trillion and is projected to reach $6 trillion by 2030. Within this market, investors are increasingly turning to actively managed strategies for bond exposure. Inflows to these strategies have more than doubled since 2019, accelerating over the last year as interest rates peaked. Active fixed-income ETF assets under management soared by nearly 284% to more than $397 billion as of February 28.

Investor appetite comes for good reason, given the accessibility provided by the ETF structure. Unlike mutual funds, for example, ETFs trade on exchanges, offering real-time pricing and the ability to quickly execute trades. Liquidity is a lifeline during market turbulence, when ETFs have consistently maintained tighter spreads than the underlying bond markets. Also, ETF trading costs are often externalized, whereas transaction costs for mutual funds are shared amongst shareholders

A Modern Structure for Modern Times

We expect active fixed-income ETFs to continue to gain significant market share as investors seek enhanced returns in this new rate environment. Managers do not just pick bonds for investors; they craft strategies capable of seizing opportunities and managing risks, while having the flexibility to pivot as market dynamics shift.

The human element provided by active management, combined with the benefits of ETF structure, can be a key differentiator for investor portfolios. Proof is in the performance. The majority of core and core-plus managers have outperformed the Bloomberg U.S. Aggregate Index over the last five years.

In our view, the ease with which investors can now integrate all corners of the bond market in their portfolios using this product has active fixed-income ETFs well on their way to becoming a cornerstone in asset allocation—and, in the process, revolutionizing how investors view and participate in fixed income.

Jon Maier is the chief ETF strategist, and Shayan Hussain is the head of the U.S. investment specialists, global fixed income, currency and commodities group for J.P. Morgan Asset Management.

This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of ISS STOXX or its affiliates.

Tags: Active ETFs, Bonds, fixed income strategies