A 'golden age' for active bond ETFs? What investors need to know before piling in as Fed prepares rate cuts

Dow Jones09-13

MW A 'golden age' for active bond ETFs? What investors need to know before piling in as Fed prepares rate cuts

By Isabel Wang

One MorningStar analyst says investors should avoid selecting ETFs based on their near-term rate expectations

Hello! This is MarketWatch reporter Isabel Wang, bringing you this week's ETF Wrap. In this week's edition, we look at actively managed bond ETFs and what has been driving investor interest in them, as the Federal Reserve is set to reduce interest rates for the first time since 2020 at its meeting next week.

Please send tips or feedback to isabel.wang@marketwatch.com or to christine.idzelis@marketwatch.com. You can also follow me on X at @Isabelxwang and Christine at @CIdzelis.

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Investors this year have piled into exchange-traded funds that invest in a handpicked array of bonds amid surging demand for active fixed-income products and uncertainty around the Federal Reserve's interest-rate outlook.

Actively managed bond ETFs had taken in $66 billion in net inflows this year as of Sept. 10, marking a 280% increase from the $17 billion recorded over the same period last year, according to FactSet and Dow Jones Market Data.

In terms of fund performance, active bond ETFs outpaced their passively managed peers over the 12 months ending June 2024 - with roughly two out of every three active bond funds beating their average passive counterparts, according to MorningStar Research Services.

Active bond funds' success over the past year can be explained by their "shared" strategic positioning ahead of the Federal Reserve's long-awaited interest-rate cuts, a team of MorningStar analysts led by Ryan Jackson, senior manager research analyst, said in a Tuesday note.

Those active bond funds tend to invest in short-term bonds and take more credit risk than their index-based peers, which has been an "ideal" combination over the past year as persistent inflation pushed back the timeline for rate cuts and credit spreads narrowed, Jackson and his team said.

Actively managed fixed-income ETFs have grown rapidly over the past year, with assets under management soaring by nearly 55% to more than $240 billion as of August, according to data compiled by MorningStar.

However, it is still a hugely untapped market for ETF issuers, as active bond funds only represent less than 14% of the total assets in the fixed-income ETF industry, Jackson told MarketWatch in a follow-up interview on Thursday.

To be sure, interest in fixed-income ETFs has swelled in 2024 as investors expect the U.S. central bank will soon start lowering interest rates, making Treasury bonds and the index funds tracking them attractive again. But concerns are still lingering as to how fast and how deep policymakers could cut rates in the coming months.

That uncertainty makes actively managed strategies more appealing to investors than passive ones, as portfolio managers could have the flexibility to "react" to risks and navigate around wild swings in the financial markets, according to Eric Bernum, portfolio manager at Smith Capital Investors.

"As we look forward to the next year, there's probably slowing economic data, and the Fed will cut at a measured pace. ... So there's the potential for very outsized outcomes in either direction [in the Treasury market]," Bernum told MarketWatch via phone on Thursday. Navigating the uncertainty, Bernum said, "is really where active management earns its key."

However, MorningStar's Jackson said investors should avoid making bond ETF-related decisions based on their near-term rate expectations, as it would be difficult to play the "rate-forecasting game" while inflation and recession concerns still linger.

"When you're letting near-term rate expectations inform your buying decisions, that's how you get caught in a precarious position," Jackson said.

As usual, here's your look at the top- and bottom-performing ETFs over the past week through Wednesday, according to FactSet data.

The good...

   Top performers                                                                                                                                                                        %Performance 
   Sprott Uranium Miners ETF                                                                                                                                                             6.8 
   Global X Uranium ETF                                                                                                                                                                  5.3 
   VanEck Semiconductor ETF                                                                                                                                                              4.1 
   AdvisorShares Pure US Cannabis ETF                                                                                                                                                    3.9 
   Technology Select Sector SPDR Fund                                                                                                                                                    3.9 
   Source: FactSet data through Wednesday, Sept. 11. Start date Sept. 5. Excludes ETNs and leveraged products. Includes NYSE-, Nasdaq- and Cboe-traded ETFs of $500 million or greater. 

... and the bad

   Bottom performers                                     %Performance 
   YieldMax COIN Option Income Strategy ETF              -9.2 
   YieldMax TSLA Option Income Strategy ETF              -7.5 
   VanEck Oil Services ETF                               -4.0 
   Invesco S&P SmallCap Value with Momentum ETF          -3.9 
   iShares U.S. Oil & Gas Exploration & Production ETF   -3.7 
   Source: FactSet data 

New ETFs

Palmer Square Capital Management on Tuesday launched the Palmer Square Credit Opportunities ETF PSQO, an actively managed, multiasset credit allocation fund, and the Palmer Square CLO Senior Debt ETF PSQA, which provides passive exposure to collateralized-loan-obligation $(CLO.UK)$ debt rated AAA and AA by tracking Palmer Square's CLO Senior Debt Index, the firm said in a press release. Simplify Asset Management on Tuesday launched the Simplify National Muni Bond ETF NMB. The fund employs an actively managed municipal-bond strategy, with the goal of achieving "attractive" income through municipal-bond coupons while simultaneously generating gains by "opportunistically" trading undervalued municipal securities, the firm said in a press release.

Weekly ETF Reads

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-Isabel Wang

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September 12, 2024 18:19 ET (22:19 GMT)

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