Wealth Management
2023 has been the year of active fixed income based on inflows and new issues. Nearly every asset manager has been jumping on the trend as we’ve seen launches from Blackrock, Capital Group, and Vanguard in the last couple of months.
The latest to join the fray is JPMorgan which announced the JPMorgan Active Bond ETF (JBND) which will trade on the New York Stock Exchange. The ETF will invest in a diversified portfolio of intermediate and long-term debt securities with a focus on securitized debt products. It seeks to differentiate itself with an emphasis on value through careful security selection and aims to outperform the benchmark, Bloomberg US Aggregate Bond Index, over a 3 to 5 year time frame. In addition, JBND has a cost basis of 30 basis points.
Active fixed income is benefitting from the current volatility and uncertainty regarding monetary policy. There’s also a fundamental shift in the wealth management space as institutions and advisors are more familiar with these types of products vs mutual funds. And, many younger advisors and investors prefer the ease and familiarity of the ETF structure vs mutual funds. Therefore, asset managers are introducing ETF versions of their most popular active fixed income funds.
Finsum: Active fixed income continues to be a hot space with JPMorgan launching another offering. Here are some reasons for the category’s growing popularity.
2023 has been a volatile year for bonds due to a better than expected economy and hawkish Federal Reserve. Yet, inflows into bond funds are up 38% compared to this time last year at $235 billion according to Blackrock.
The firm sees fixed income demand driven by high yields and the desire to reduce portfolio volatility. Currently, the 10 year Treasury is yielding 4.6% which is 90 basis points higher than at the start of the year. In contrast, the 10 year was yielding around 1% in October 2021.
Currently, the central bank is in a ‘wait and see’ mode regarding further hikes and the duration of the current cycle. Wall Street analysts anticipate that flows should further pick up once it’s clear that the tightening cycle is over as they look to lock in yields at these levels.
In terms of fixed income ETFs, the iShares 20+ Year Treasury Bond (TLT) has been the biggest beneficiary with $17 billion of net inflows YTD despite a 13% drop. However, there is less enthusiasm for riskier fixed income due to concerns that a recession could lead to a spike in defaults as inflows into lower-rated bond funds have lagged.
Finsum: Fixed income inflows have been strong all year despite considerable volatility and uncertainty about the economy and Fed.
At one time, direct indexing was only available and viable for ultra high net worth investors. This is now changing due to technology which is simplifying the process, the sharp decline in trading commissions, and the fractionalization of shares.
With direct indexing, investors and advisors can replicate any index in a managed account. Instead of buying a mutual fund or an ETF, an investor buys the actual components of an index. This comes with added benefits as they can tweak or adjust the holdings of the index to suit their own inclinations or unique situation. It also means that these investors can harvest tax losses which can then be used to offset taxes from capital gains in another part of the portfolio.
With direct indexing, tax loss harvesting can lead to better performance especially in more volatile years for the market. Even in up years, some segments of the market may finish in the red which provides opportunities to harvest losses to offset gains.
Direct indexing is particularly useful for investors who have strong beliefs or unique financial situations. For instance, an investor who does not want to invest in tobacco companies can eliminate these from an index and choose another stock which has similar factor scores to ensure that the benchmark continues to be tracked.
Finsum: Direct indexing is an effective strategy to lower tax bills but is only accessible for a tiny segment of investors . Now due to technology and lower commissions, it’s available to nearly everyone.
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In recent weeks, there has been a major outflow out of fixed income ETFs, following the breakout in long-term yields to their highest levels since 2007. According to Bill Gross, the co-founder and former CIO of PIMCO, retail ETF investors are reducing their holdings and contributing to volatility.
He commented in a CNBC interview that “Over the last few days, large bond ETFs that number in the $100bn range, are experiencing higher volume, which indicates small investor vigilantes are selling. They have been spooked over the last week or so by declines of 3%, 4% and 5% in their bond ETFs.”
In terms of the bigger picture, he attributes the weakness in fixed income due to the federal government’s $2 trillion deficit and the large amounts of incoming supply necessary to finance it. Another contributing factor is the Federal Reserve’s quantitative tightening program which is also adding to supply. Ultimately, he sees yields on 10-year Treasuries reaching as high as 5%.
He believes the Fed is done hiking this cycle. However, he doesn’t see much upside for long-duration fixed income even if the Fed starts cutting rates due to sticky inflation, nearly 30% of Treasury supply maturing in the next couple of years, and structurally high deficits.
Finsum: Bill Gross shared some thoughts on the bond market and how recent fixed income ETF outflows are contributing to volatility.
JPMorgan shared its outlook for fixed income in Q4. Its two base case scenarios, each with 50% probability, are below-trend growth and a recession. The bank also cut the odds of a crisis to zero due to inflation pressures moderating.
They believe the economy is on a soft-landing trajectory but warn that there are many similarities between a ‘soft landing’ and the early stages of a recession, meaning that investors should remain vigilant despite recent constructive developments.
The major risk to the outlook is inflation re-igniting which could result in more hikes and extend the duration of hawkish monetary policy. The next few months may be a challenge due to the headwinds from a slowing economy and high rates. Therefore, JPMorgan recommends short-duration, securitized credit to take advantage of generous yields while minimizing duration and default risk.
From a longer-term perspective, they see an opportunity to buy the dip in fixed income as both recessions and sub-trend growth environments are bullish for the asset class. There is uncertainty with regards to timing given that the Fed is in a ‘wait and see’ mode. Yet, history is clear that bonds will catch a strong bid once it’s evident that the Fed is done hiking.
Finsum: JPMorgan shared its Q4 fixed income outlook. Its two base-case scenarios are a recession and a period of below-trend growth.
The fixed income complex saw further losses following the September jobs report which showed that the US economy added nearly twice as many jobs than consensus expectations. Additionally, July and August payrolls were revised higher by a cumulative 119,000. In concert, this data refutes the notion that the jobs market is losing momentum.
The heaviest losses were felt in longer duration bonds, while shorter duration notes had mild weakness. This is a continuation of the major trend of the last couple of months which has seen the yield curve flatten due to a breakout in longer-term yields to the highest levels in 16 years. The major impetus for this move is the market reducing the odds of a recession and rate cuts in 2024 given that the economy has performed better than expected, while inflation has seemingly plateaued at high levels.
The bullish case for fixed income rests on the economy or inflation rolling over. In terms of the economy, there certainly is evidence of decelaration but nothing to indicate sufficient contraction that would cause the Fed to pivot. Regarding inflation, there are some positives with moderation in wage growth and rents, however this has been offset by rising energy prices and concerns that the autoworkers strike will lead to an increase in used and new vehicle prices.
Finsum: Fixed income was down following the September jobs report which was surprisingly positive further reducing the odds of a recession in the first half of 2024.