Wealth Management
For cautious-minded investors, active fixed income could be a much better option than cash. This is according to SPDR Exchange Traded Funds’ Managing Director and Head of Research, Matthew Bartolini, who notes that some of the major advantages of active fixed income are that it offers more flexibility, consistent performance, and can be more tax efficient. Overall, it can help portfolios generate income, dampen volatility, while still retaining exposure to upside opportunities.
Many advisors and investors are already aware of these benefits as active fixed income has taken a large portion of flows relative to its size compared to passive fixed income and equity ETFs. As Bartolini notes, “Active fixed income has been really a consistent engine of support within the active [ETF] construct — not only from flows but also returns.” Another factor in active fixed income’s growth is that it allows investors to take advantage of elevated yields.
Bartolini also believes that future returns will be appetizing for the asset class, although there will be some volatility to stomach. He also believes that cash is less desirable due to the reinvestment risk. His major focus is on constructing portfolios to generate income while properly balancing risk.
Finsum: Active fixed income is seeing major growth in terms of inflows. Here’s why the asset class is well-positioned for the current moment given the combination of elevated yields and an uncertain macro environment.
ETF investors are extremely price sensitive. This is indicated by data showing the dominance of equity and fixed income ETFs with total expense ratios below 30 basis points in terms of inflows. ETFs below this threshold captured 97.8% of equity inflows and 99% of fixed income ETF inflows.
When looking at the total market, equity ETFs below 30 basis points account for 76.9% of assets, and fixed income ETFs below this level account for 85.5% of the market. Over the last decade, costs have drifted lower. Equity ETF average fee declined from 0.39% to 0.23%, and fixed income ETF cost dropped from 0.25% to 0.20%.
A recent example of this trend is State Street Global Advisors reducing its fee on the popular SPDR S&P 500 ETF (SPY) from 0.09% to 0.03%. This move also led to a surge of inflows.
According to Athanasios Psarofagis, ETF analyst at Bloomberg Intelligence, lower costs are a result of a more mature market. He also sees this trend continuing as he notes that “Over the long-term it is hard for active mutual funds to outperform the benchmark consistently. As ETFs grow, it will continue to put pressure on active managers to reduce their fees.
Finsum: ETFs with cost basis under 30 basis points are dominating in terms of inflows and represent the majority of total assets in ETFs. Here’s why this trend should continue.
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.
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Decisions made by model portfolio managers are showing that investors are starting to get cautious about valuations of megacap tech stocks. These stocks have been the biggest gainers this year in the stock market. Tech stocks with market caps above a trillion dollars are up more than 50% YTD, while the S&P 500 is up 19%. 2 major catalysts for this group have been the perception that rates have peaked and a frenzy for securities connected to artificial intelligence.
Of course, many market-cap weighted or tech-focused indices will have outsized exposure to this group. According to Brooks Friederich of Envestnet, an intermediary which operates a platform that offers customized products from asset managers, “End-clients are saying ‘I want an investment product that isn’t going to have all this exposure to the big-tech stocks,’ If you look at retirement portfolios, they all have too much exposure to that because of the construction of the market.”
He also adds that balanced portfolios continue to have appeal and are a major reason for the boom in model portfolios given the ease of combining asset classes. More than half of the assets on its platform are linked to 60/40 or 70/30 portfolios despite the poor performance of fixed income as a hedge against equities last year.
Finsum: Model portfolio end-clients are showing some concerns about the valuations of megacap tech stocks, while remaining committed to balanced portfolios despite recent volatility.
In a CNBC interview, Blackrock COI Rick Rieder shared some thoughts on Blackrock’s newest active fixed income fund, and why he believes that active fixed income offers several advantages for investors.
Active fixed income managers have the latitude to seek opportunities that are beyond what’s represented in the indices. As an example, he cites the Blackrock Flexible Income ETF (BINC) which has outperformed its peers since its inception in late May. Over this period, BINC is up 0.3%, while the iShares Core US Aggregate Bond ETF (AGG) is off by 4% and the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) is down 0.2%.
BINC’s biggest allocation is to bonds outside of the US at 22% with US high yield debt and US investment grade debt accounting for 17% and 14%, respectively. According to Rieder, the stronger US dollar is leading to more attractive opportunities overseas.
Passive funds are unable to take advantage of these opportunities. Another advantage for active fixed income is that certain pockets of risk can be avoided as well. He cites this combination as why active fixed income has outperformed, since it leads to more yield and reduced volatility.
Finsum: Blackrock CIO Rick Rieder explained some of the structural advantages of active fixed income to identify opportunities and avoid pockets of weakness.
In a strange quirk, millennial investors have a greater allocation to fixed income than older generations according to a recent survey from Charles Schwab. Millennials currently have 45% allocated to fixed income, while Generation X and baby boomers have 37% and 31%, respectively. Looking ahead, 51% of millennials plan to buy fixed income ETFs next year while 45% of Generation X and 40% of baby boomers plan to do so.
Of course, this is contrary to the conventional thinking that younger investors should have greater capacity for risk given that they have a longer timeframe to ride out volatility to earn higher returns. However, this conservative positioning could be a reflection of the extraordinary events that have taken place over the last couple of decades which have likely shaped their attitudes. These include the dot-com bubble, the financial crisis in 2008, and the pandemic.
Thus, many millennial investors are focusing more on reducing risk with their high levels of exposure to fixed income while eschewing equities. According to David Botset, the head of strategy and product at Schwab Asset Management, stocks are the ‘growth engine’ of a retirement portfolio so underexposure could have negative long-term implications.
Finsum: Millennial investors have lived through unusually volatile markets which have impacted their thinking and led to an overallocation to fixed income.