Wealth Management
In an article for CNBC, Sean Conlon discussed some factors behind the rise in demand for fixed income ETFs. Despite some softening in the economy and in terms of inflationary pressures, the Fed seems intent on hiking by another quarter point at its next meeting.
This is leading to juicy opportunities in the fixed income space which may not last if inflation does continue to trend lower or a recession materializes in the second half of the year. Additionally, current futures markets are forecasting that the Fed will be cutting rates by the end of the year. As noted by Vettafi, this dynamic is leading to inflows into Treasuries, corporate bonds, and high-yield bonds as investors look to lock in duration and yields.
Since the start of the year, there was about $45 billion in inflows into fixed income ETFs. Another factor behind this demand is the underperformance of traditional asset allocation models like 60/40. This is leading many investors to get more conservative and examine the fixed income space for opportunities.Until market stresses ease, demand for fixed income ETFs should remain elevated.
Finsum: Fixed income ETF demand rose sharply in Q1. Given the Fed’s hawkish bent and current market conditions, this should persist.
In an article for Vettafi, James Comtois laid out some of the benefits of direct indexing for investors. Direct indexing has grown in popularity for certain investors because it leads to greater tax savings and customization than traditional passive and active funds.
In terms of taxes, direct indexing allows investors to sell losing positions and then buy back stocks with similar characteristics. Then, these tax losses can be harvested and used to offset capital gains, leading to a lower tax bill.
Another beenfit of direct indexing is that it allows investors to have their personal values and preferences reflected in their investments. For instance, an investor may be uncomfortable with companies in a certain industry and can exclude them from being considered for investment.
Many investors may also be in a unique situation such as having large exposure to a particular company due to stock options or family holdings. Direct indexing allows them to construct a portfolio that reduces this particular exchange, leading to a more resilient portfolio and financial situation.
Finsum: Direct indexing is growing in popularity as it offers some advantages of traditional funds. However, it’s likely not appropriate or necessary for most investors.
In March, investors withdrew a total of $5.7 billion from US-listed ESG ETFs, leaving ESG funds with total assets of $81 billion according to reporting from Barron’s Lauren Foster.
A major factor in the outflows was Blackrock rebalancing its passive holdings which resulted in a $3.9 billion outflow in a single day. Other factors that accounted for this were cited as political backlash, increased regulatory scrutiny, poor performance, and market volatility.
In Europe, ESG flows are also depressed relative to 2021 but remain positive. In the US, it’s become a political issue as many conservatives are criticizing corporations for involvement in political affairs. Recently, President Biden vetoed legislation that would prevent pension funds from considering ESG factors in their investments.
There has also been some movement at the state level where conservative leaders are pursuing actions such as divesting from financial institutions that don’t invest in energy companies or companies engaging in political activity. So far, these efforst have failed but show that the tide could be turning against ESG.
Finsum: ESG funds saw major outflows in March due to a variety of factors. However, it’s clear that ESG is increasingly becoming a political issue.
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In an article for Advisor Perspectives, Scott Welch and Kevin Flanagan of WisdomTree shared some strategies that can be used to generate income in the current market whether using model portfolios or ETFs.
Of course, this is a big change from the last decade when the Fed’s dovish policies meant that dividend yields on equities exceeded bond yields for the most part. This is no longer the case as the Fed is waging an aggressive hiking campaign to curb inflation even at the cost of a bump in the unemployment rate or a recession.
Thus, the Fed has already hiked rates to 5% and is forecast to hike two or three more times before the current cycle is terminated. More important, the Fed is ‘data-dependent’ and willing to change course depending on inflation and/or financial stability concerns.
This uncertainty and elevated rates mean there is a plethora of opportunities for investors to find income. For those who are comfortable with duration risk, high-yield bonds and equities are an option in addition to ETFs. For those not comfortable with duration risk, shorter-term notes and floating rate options are a good fit.
Finsum: After more than a decade of a paucity of options for income investors, the current market is offering a variety of opportunities.
About 14% of advisors are aware of and recommend direct indexing solutions to their clients which is the primary reason that its forecast to grow faster than ETFs over the next decade. In a recent article by Allen Roth of WealthLogic, he discusses the pros and cons of direct indexing and compares it to ETFs.
Direct indexing has many of the same characteristics as ETFs such as allowing exposure to broad categories and having low costs. However, it allows for greater customization that can allow for portfolios that are more tailored to a client’s needs.
Another distinct advantage of direct indexing are that it allows for tax-loss harvesting which can offset capital gains. This strategy can allow for an additional 0.2 to 1% of returns and is more beneficial in down years.
In terms of disadvantages, many of the most popular ETFs have less costs than direct indexing. For example, the most popular S&P 500 ETFs have annual expenses of 0.03%, while most direct indexing fees are in the 0.4% range.
While this won’t make a different in the near-term, it will matter in the long-term especially as tax-loss harvesting benefits erode over time. Additionally, the slight tax benefits may be outweighed by the tax complications as each trade needs to be accounted for.
Finsum: Direct indexing is expected to grow at a faster rate than ETFs over the next decade. Yet for many investors, ETF remain the better choice.
After a decade of low rates and abundant central bank liquidity, market conditions are going to be much more challenging over the next decade. According to Jason Xavier, Head of EMEA ETF Capital Markets at Franklin Templeton, these developments mean that a major opportunity is brewing for active fixed income ETFs. He discussed this in a post for Franklin Templeton’s Beyond Bulls & Bears publication.
While most fixed income ETFs are passive, the active category is exploding in response to the need of investors to express various views. In contrast to passive strategies, active ETFs utilize fundamental analysis and have greater discretions on which instruments they can select rather than be limited by an index. Active managers have greater flexibility to respond to a change in market conditions or external catalysts unlike passive managers.
In the fixed income space, the ETF structure leads to increased price transparency and liquidity especially compared to traditional bond markets which are typically quite opaque. ETFs also give smaller investors access to fixed income opportunities which were typically only available to high net worth investors or institutions.
In sum, Xavier believes active fixed income ETFs will continue to see growth as they are likely to outperform in more volatile conditions and will lead to increased transparency and liquidity in the fixed income market.
Finsum: Franklin Templeton’s Jason Xavier sees the active fixed income ETF category continuing to rapidly grow as it offers major benefits to investors.