Active bond ETF managers have outperformed their passive counterparts amid the current interest rate climate, driving strong capital inflows and impressive returns. Despite persistent criticism over higher costs, investors appear willing to pay a premium for performance.
“We are at the early stages of what could be a golden era for actively managed fixed-income ETFs,” said Todd Rosenbluth, head of research at VettaFi.
Active ETFs are often regarded as active management wrapped in an ETF structure. In Europe, fees for active fixed-income ETFs average 30 basis points, significantly lower than the 64 basis points charged by traditional mutual funds. Yet, the higher fees of active strategies can only be justified through superior performance—something that now seems evident, particularly in the fixed-income space.
According to Morningstar’s semi-annual U.S. Active/Passive Barometer report, two-thirds of active bond ETFs outperformed their passive peers in the year ending June 2024.
The outperformance has been especially pronounced in medium-term core bond funds, where 72 percent of active strategies succeeded. This is largely attributed to their shorter duration and a more aggressive stance on credit risk, which has paid off as interest rates have risen and credit spreads have tightened.
Skilled active managers can exploit market inefficiencies, adjusting duration and credit exposure with greater agility than index-tracking passive ETFs. This flexibility enables them to capitalise on falling interest rates more effectively than their passive rivals.
Inflows surge
The success of active bond ETFs has not gone unnoticed by investors seeking strategies that can navigate a shifting interest rate environment. Inflows have been robust, with 74.1 billion dollar flooding into active fixed-income ETFs in the first 11 months of 2023—well above the 54 billion dollars recorded for the whole of 2022. Both S&P’s Spiva report and Morningstar’s data confirm that active fixed-income management has a greater likelihood of outperforming passive strategies.
While active real estate funds also performed well, boasting a 66 percent success rate over the same period, actively managed equity funds have been more inconsistent. Large- and small-cap equity strategies achieved success rates of 53 percent and 52 percent, respectively, while mid-cap funds managed just 36 percent.
The case for active bond ETFs
Bryan Armour, director of passive strategies research for North America at Morningstar, explained the appeal: “Active management in fixed income can add value through sector rotation, security selection, and yield curve positioning.”
However, Neal Kosciulek, research analyst at Morningstar, warned against assuming all active strategies will deliver: “Just because a fund is active does not mean it is good,” he says, urging thorough due diligence, particularly as many active bond ETFs still lack long-term track records.
Despite the potential for outperformance, active bond ETFs come with higher costs. The average expense ratio for active intermediate-core bond ETFs stands at 0.41 per cent, compared to just 0.06 per cent for passive alternatives in the same category.
Challenges in the long run
Despite strong short-term performance, the long-term outlook for active strategies remains challenging. Over a ten-year period, only 29 percent of active bond funds have consistently outperformed their passive peers, according to Morningstar. The 2023 Spiva scorecard paints an even starker picture, with 96.83 percent of all domestic funds underperforming their benchmark indices over a 20-year horizon.
Nonetheless, Morningstar’s research suggests that investors are becoming more adept at identifying high-performing active funds. Over the past decade, the average dollar invested in active funds has outperformed passive funds in 19 out of 20 categories analysed.
Record inflows continue
According to ETFGI, an independent research and advisory firm specialising in the global ETF market, assets invested in actively managed ETFs globally reached 923.2 billion dollars by 30 June. This represents a nearly 32 percent increase from the 739.9 billion dollars reported at the end of 2022.
In July alone, actively managed ETFs attracted 35.9 billion dollars in net inflows globally, bringing the total for the year to 31 July to 190 billion—more than double the previous record of 86.1 billion for the first seven months of 2023, ETFGI data shows.
Deborah Fuhr, managing partner and founder of ETFGI, attributes this growth to an expanding investor base and an increasing array of products across geographies. “Products from well-known managers and the growing preference for ETFs over mutual funds, particularly in the US, have driven this surge in assets and net inflows,” she said.