Charts with Chartolini: Active Fixed Income ETFs Getting Stronger

The theme over the past few years for active fixed income ETFs has been like every training montage in the Rocky movies – constantly getting stronger. And now, the chorus from Bill Conti’s “Gonna Fly Now” is running through my head as I write.

There might be no punching of frozen meat carcasses, chasing chickens, running through the streets of Philadelphia, or racing your best friend on a beach, but active ETFs have put in the hard work. And the hard work, like Rocky chopping wood in the Russian mountains in Rocky IV, has paid off, culminating in $130 billion of assets today and strong growth (43% CAGR) over the past 10 years.1   

The Early Rounds

In 2011, there were only 25 active fixed income ETFs, with assets of just $3 billion spread over 12 different Morningstar categories. Yet, the assets were concentrated, with 90% confined to just three categories. Given that the first active fixed income ETF was launched in 2008, this slow burn over the early few rounds was not surprising. The use of an ETF wrapper for active strategies was new and a performance track record for any active strategy is important – and that takes time.

By 2016, active fixed income ETFs had broken the $20 billion asset mark, and the number of funds had more than doubled to 79. Diversity had also improved, as assets were spread across 19 different Morningstar categories with nine of those segments having more than $500 million in total category assets. Yet, new fixed income ETFs coming to the market were still primarily passive. That all changed after 2016. Not to the degree of Rocky changing gears in his Lamborghini while Robert Tepper’s “No Easy Way Out” plays in Rocky IV, but there was a noticeable shift.

Starting in 2016, more than 10 active fixed income ETFs were launched each year. As a result, 42% of all fixed income ETF launches over the past five years were active, compared to just 22% in the prior five years. In fact, in 2017 nearly half of the fixed income ETF launches were active.

The increase in launches and category coverage speaks to the increase in confidence in the ETF wrapper, by  investors as well as issuers who could now run a variety of strategies as a result of a change in listing standards in 2016 that allows active ETF mandates more flexibility and to be on par with active mutual funds.2 

Punching Above Their Weight

I see 2016 onward as the “the Russian is cut moment” within fixed income ETFs – the realization that active ETFs are a force to contend with, even though their passive ETF counterparts are massive (like the dynamic between Rocky and Drago). 

Starting in mid-2017, active fixed income ETFs reeled off 42 out of 46 months of market share gains (91% of observable periods) versus pure passive within the fixed income ETF category. These share gains contrast to the prior period, where market share gains occurred in just 63% of the months.

This strong run of Rocky versus Clubber Lang-like power punches (the second fight in Rocky III) has pushed active fixed income ETFs’ current market share to over 11%, up from just 5% in 2017. Flows have naturally been the driver of these gains, as during this timeframe the average flow figure was $2 billion a month – a 439% increase above the pre-2017 prior five-year average – with only five months registering flows below $1 billion. In fact, right now, active fixed income ETFs are currently on there longest-ever streak of flows over $1 billion, at 15 months.  

What is more interesting is that active fixed income ETFs did this while their active mutual fund counterparts were losing share. As shown below, within the fixed income category active bond ETFs have steadily grown their market share, with the inverse is true for mutual funds. Active fixed income mutual funds have been consistently losing share to passive for the better part of a decade now. 

The increase in market share by fixed income ETFs, bucking the trend of active fixed income mutual funds, illustrates that the newly launched strategies were being met with strong demand and utilized in portfolios alongside traditional beta strategies as well as legacy mutual funds. 

Making the Punches Count

The punches thrown by active fixed income ETFs have counted too, like the body shots Rocky hit Apollo with in Rocky I.  

Except for 2018, more than half of the active managers have beaten their prospectus benchmark each year. The same is true on a one-, three-, and five-year basis – with the five-year number at 70%. And, as shown below, the magnitude of average excess returns from the managers outperforming in the calendar years (and periodic periods) averages 1.29%, indicating that when managers outperformed that they beat their benchmarks by good margins.  

These strong returns have also come in a more efficient manner than mutual funds, as the median fee on active fixed income ETFs is 40 basis points compared to 69 basis points for active bond mutual funds.3 Greater  tax efficiency has also boosted  after tax returns versus traditional active bond mutual funds. Since 2016, only 18% of active fixed income ETFs paid capital gains each year. This compares to 27% for active fixed income mutual funds over the same time period.4 

Eye of the Tiger

With the strong run of flows and market share gains, active fixed income ETFs have the eye of the tiger right now – rising up to the challenge of their rival. The environment is also likely to continue to support their growth as investors desperately seek income. And active mandates may be able to meet this need, given their ability to rotate among higher yielding market sectors while also managing overall portfolio risk.

For those seeking active bond mandates today, ETF strategies may be the go-to choice considering: the introduction of more strategies along with lower fees and stronger after-tax profile than mutual funds. I don’t expect a “Yo Adrian, I did it” outcry for active fixed income ETFs by the end of this year, but over $150 billion in assets is within reason – with a puncher’s chance of more than $200 billion in assets by the end of 2022.5  

Footnotes

1 Per Morningstar data as of May 31, 2021. Calculations by SPDR Americas Research.

2 https://www.morganlewis.com/pubs/2016/08/sec-approves-generic-listing-standards-for-active-etfs

3 Per Morningstar data as of May 31, 2021. Calculations by SPDR Americas Research.

4 Per Morningstar data as of May 31, 2021. Calculations by SPDR Americas Research.

5 Per Morningstar and Bloomberg Finance L.P. data as of May 31, 2021. Calculations by SPDR Americas Research. Projections based on the average monthly flows over the last three years and current assets today.  

?Important Risk Information

The views expressed in this material are the views of Matthew Bartolini through the period ended June 24, 2021 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.

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3645975.1.1.GBL.RTL

Exp Date. 6/30/2022