Displaying items by tag: mutual funds

2023 saw many twists and turns in financial markets. Yet, one enduring trend was the growth of active and fixed income ETFs as measured by inflows and new ETF launches. Andres Rincon, the Head of ETF Sales and Strategy at TD Securities, shares why this was the case and what’s next for 2024.

A major factor is that mutual funds had net outflows, while ETFs had nearly an equivalent amount of inflows. This is an indication of a secular shift as investors and institutions increasingly favor ETFs due to more liquidity and transparency. In response, many asset managers are now converting fixed income mutual funds into active ETFs or offer dual versions.

Fixed income ETFs also benefited from yields being at their highest level in decades in addition to an uncertain economic outlook. Despite the rally in fixed income in the last couple of months of 2023, Rincon notes that investors had been positioning themselves for a downturn in the economy and pivot in Fed policy starting early in the year. 

Flows into active fixed income ETFs have also been strong, given that fixed income is more complex than equities. This is despite these ETFs typically having higher fees. Yet, active managers are able to take advantage of inefficiencies that are unavailable to passive funds. And, active is a particularly good fit for the current moment when there is indecision about the timing and extent of the Fed’s next move.

Finsum: TD’s Andres Rincon discusses what drove the surge of inflows into fixed income and active ETFs last year. And, why these trends should continue in 2024. 

There’s a major drawback to today’s hyper-connected world where investors are constantly receiving financial advice that is mostly short-term and doesn’t necessarily have the investors’ best interests in mind. Contrast that approach to a long-term, fundamental based approach that is based on timeless principles rather than impulsive thinking.

Recently, there has been a narrative that individuals should be buying individual bonds. Adam Abbas, a portfolio manager at Oakmark Funds, pushed back against this notion and made the case for why most investors are better off with mutual funds and ETFs. 

He acknowledges that bonds look very appealing given where rates are relative to historic levels and that default rates for high-quality securities are likely to remain low. However, the risk climbs when investors start ‘reaching for yield’ which tends to happen with individual investors. Therefore, some sort of comprehensive credit analysis is required from a bottom-up perspective. 

Further, most individual investors will not be able to sufficiently diversify their portfolios. This means that their portfolios would be damaged by a corporate bond default. In addition to understanding companies, investors also need to have a grasp on the macro picture as factors like inflation or rate policy can also impact returns. 

Given these difficulties, most investors are better off choosing an astute active manager to invest in bonds as they will conduct proper due diligence and ensure that portfolios are sufficiently diversified. 

Finsum: There’s a trend of individual investors buying individual bonds. Oakmark’s Adam Abbas pushes back against this and makes the case for why most investors are better off with a mutual fund or ETF. 

Separately managed accounts (SMAs) have been utilized for decades to effectively manage client assets. Benefits include transparency, flexibility, control over costs, and choice. They can be optimized for various purposes including taxes, income, cash flow, etc. They also allow for more customization than ETFs or mutual funds. 

They are particularly popular for fixed income purposes and have seen impressive growth in recent years. For instance, municipal fixed-income assets went from $100 billion in 2008 to $718 billion in July 2023. In part, this is due to SMAs becoming more accessible to a wider universe of investors as improved technology has led to lower costs and lower minimum amounts to invest. 

ETF’s presence in the municipal bond market is also growing fast. There are now 81 funds and $108 billion in assets, a 50% increase from 2021 but less than 3% of the total muni market. Many active mutual funds are being converted into active ETFs. One advantage is greater liquidity which allows investors to quickly gain exposure as a placeholder while they accumulate individual securities.

Mutual fund flows can be affected by market sentiment, leading to selling during periods of redemption, which is not an issue with SMAs. Due to the growth of SMAs and ETFs, muni mutual funds have seen net outflows over the last couple of years. Another factor is high rates making short-term securities or bank deposits more attractive relative to longer-duration assets. 

Finsum: There are multiple ways to invest in municipal bonds. One of the fastest-growing methods is through separately managed accounts which offer some specific benefits relative to ETFs or mutual funds. 

Direct indexing has been around for 30 years but was once only accessible and viable for ultra-high net-worth investors. Now, technology and lower transaction costs have made it available for a much wider swath of investors who are able to benefit from direct indexing’s tax-loss harvesting and customization abilities.

Interestingly, the strategy is finding particular favor among millennial investors who are interested in tax optimization and personalization which are not possible through traditional passive investing. Advisors can customize holdings in a way that reflects a client’s values and preferences such as prioritizing ESG criteria or adjusting a portfolio based on a client’s risk profile. Holdings can also be customized to account for a clients’ unique financial situation, which is also not possible through investing in ETFs or mutual funds. 

For advisors, it presents an opportunity to differentiate themselves in a competitive landscape by offering personalized and optimized solutions. Direct indexing is likely to continue growing as it’s becoming increasingly available through many online brokerages and wealth management firms. It’s also consistent with many younger investors’ desired preference to have their personal holdings reflect their values and beliefs. 

Finsum: Direct indexing is growing at a rapid pace, and it’s finding favor with Millennial investors due to its tax optimization and personalization.  

According to a report from Cerulli Associates, direct indexing will grow faster than ETFs, mutual funds, and separately managed accounts (SMA) over the next 5 years. Currently, it’s estimated that total assets under management for direct indexing strategies will exceed $800 billion by 2026 from $462 billion at the beginning of last year. 

Another factor that should support direct indexing’s growth is that only 14% of financial advisors are aware of direct indexing and actively recommend it to clients. It’s estimated that 63% of advisors have a client with over $500,000 in investable assets, while 14% of advisors focus on clients with over $5 million in assets. Direct indexing offers the most clear advantages for high net worth clients. For advisors, it’s an opportunity to offer a differentiated service especially as tax management and customization are highly valued by many prospects. 

Direct indexing is growing in popularity as it allows investors to retain the major benefits of index investing while accessing greater personalization and unlocking certain tax advantages. With direct indexing, clients own the actual components of an index as opposed to an ETF or mutual fund. This leads to more potential for tax loss harvesting and customization to suit a clients’ particular needs or construct a portfolio that aligns with their values. 

Finsum: Direct indexing is forecast to grow faster than many ETFs, mutual funds, and SMAs over the next 5 years. Here are some of the key reasons for its growth, and why advisors should pay attention.