A recent blog post by the UBS Chief Investment Office analyzed the performance of active fixed income managers in 2022. Given the rise in rates and challenging macro environment, it’s not surprising that there was a large dispersion in returns which rewarded active managers who were able to successfully navigate the turbulence. 

Another factor contributing to this dispersion was the outperformance of short duration bonds as compared to longer duration ones. Similarly, floating rate bonds also outperformed vs fixed rate. In municipal and corporate debt, higher quality outperformed lower quality. 

As a result, many active fixed income managers were able to outperform their benchmarks. However, there are some challenges when it comes to assessing active manager performance. Fro one, fixed income indices’ individual holdings are often illiquid and don’t reflect transaction costs. 

With these caveats in mind, there are still some important takeaways to consider. Active managers tend to perform better in less efficient markets, where there is more opportunity for alpha. Additionally, active managers tended to outperform when they had more flexibility to take advantage of various drivers of potential outperformance. 

Finsum: Active fixed income managers outperform vs passive indices in 2022. Here are some reasons why.

In an article for the Financial Times, Henry Timmons discussed the positive effects on bond market liquidity due to the increased proliferation and use of fixed income ETFs. 

In essence, the innovations that have already led to more liquid and transparent markets in stocks and commodities are now happening in the fixed income markets. Despite waves of financial innovation, the bond market has been slow to adapt until recently. 

Some reasons for this are capital requirements at large banks leading to less inventory of corporate bonds on dealer balance sheets, central banks vacuuming up massive swathes of government and mortgage debt, and market participants who were resistant to change.

However, this state of affairs is being disrupted by ETFs which trade on exchanges and have tighter bid-ask spreads than what is found in individual bonds. In fact, many now look at fixed income ETFs for price discovery due to these factors. 

Of course, there are some detractors who contend that liquid fixed income ETFs which hold illiquid bonds could lead to financial instability in the event of a market downturn. Yet, fixed income ETFs were resilient in 2022 which was the worst year for bonds in decades.

Finsum: Fixed income ETFs are rapidly growing and having positive effects on bond market liquidity even if the underlying bonds remain illiquid.

In an article for Vettafi, James Comtois discussed some considerations of using direct indexing to build a portfolio. Direct indexing differs from investing in index funds, because the investor is directly owning the securities. It allows for greater customization to account for an investors’ desired factors, values, tax benefits, and concentrated positions.

The trend has accelerated in recent years, as it’s increasingly available to smaller investors. Between 2015 and 2021, direct indexing’s assets under management tripled. Yet, there are some complicating factors that need to be considered for clients and advisors.

An example is the frequency of tax-loss harvesting. Various providers of direct indexing differ in terms of conducting these turnovers on a daily, monthly, or quarterly basis. According to Vanguard, the higher the frequency of these scans, the greater the returns with a difference between 20 basis points to 100 basis points of alpha. 

Another consideration is the possibility of tracking errors. Vanguard estimates that tracking errors can lead to slippage between 75 and 275 basis points. As customization increases, the risk of tracking errors also increases. Therefore, investors need to weigh these downsides against the potential benefits.

Finsum: Direct indexing continues to gain in popularity due to it allowing for increased customization and tax benefits. Yet, there are some downsides to consider.

You strategize, financial advisors.

According to Fidelity Investments, the portfolios they’re putting together for clients reflect not only swelling caution but returning to diversification globally, reported investmentnews.com.

“This isn’t just about moving to cash when you sense trouble, we’re seeing allocations dialing up safety within the individual asset classes,” said Mayank Goradia, head of investment product analytics and strategy at Fidelity Institutional.

Among items that rose above the pack in Goradia’s report: a 32% average allocation to fixed income across all the model portfolios. That’s the highest level since the first quarter of last year. 

Meantime, here’s a regular Rubik’s cube of a process for you: turning the financial portfolio of a prospect – or existing client – to the recommended investment strategy, according to advent.com.

Hardcore diligence oversight along with the right tools, constraints – such as taxes and restrictions – can at least temporarily put the process on ice and, over time, take a portion of the client base off-model. The result: performance dispersion like investment goals.

Rain, shine or, well, active fixed income ETFs.

Point is, in light of tumultuous market conditions, it appears the time’s right for then to shine, said Jason Xavier, head of EMEA ETF Capital Markets, according to global.beyondbullsandbears.com.

“Active, active, active! Everywhere we turn, we are hearing that a new dawn is upon us, and it is once again the time for active management,” he said. “Many would be surprised that I totally agree. As outlined in my 2023 predictions, one could argue the decade of ‘cheap’ money and record-low interest rates has passed, and those skilled enough to navigate these volatile markets will certainly do well.

That said, he sees plenty of potential down the line: the dawn of the active fixed income In the ETF vehicle. The ongoing assumption that ETFs are solely passive vehicles? Mythical, said Xavier, noting ETFs are forever evolving. In doing so, they’re helping address developing investor needs. Not only that, a range of ETFs now are offered by asset managers.

With the reemergence of the chance for active management, one thing’s obvious, he noted: significant expansion should be in the cards for active ETFs—and in particular active fixed income ETF.

Meantime, in the aftermath of a topsy turvy time last year, Treasury yield is on a terrain unsees in well over 10 years, according to mfs.com.

The driver: higher as well as stickier inflation than anticipated, not to mention big time uncertainty revolving around the pace and depth of tightening by the central bank. Global markets absorbed a bruising. Income, today, has returned to fixed income.