Actively managed ETFs for bond investors

Since interest rates and yields began rising last year, many investors have rediscovered how bonds can offer income as well as ballast for their portfolios against stock market volatility. But adding bonds to your clients' mix of assets can be more complex than investing in stocks. For one thing, there are far more bonds that investors can purchase than there are stocks. Bonds vary widely in terms of credit quality, maturity, interest payments, and more. Even a group of bonds issued by the same company or government can have meaningful differences that may affect their prices and whether you want to own them or not.

Although bonds may be thought of as less "risky" than stocks, diversifying your portfolio is as important for managing risk with bonds as it is with stocks. However, building your own portfolio of individual bonds with a wide range of maturities and issuers can require a larger investment of money and time than many investors may be able or willing to make.

Those realities of the bond markets can make it challenging to construct a portfolio that meets your needs. Fortunately, actively managed exchange-traded funds (ETFs) that invest in bonds may offer a solution.

Why be active?

Low costs and easy trading have earned ETFs plenty of fans since the first ETF was launched nearly 30 years ago. While ETFs grew out of a passive, index-tracking approach to investing, more actively managed ETFs than passive ones have been launched over the past 2 years. Actively managed ETFs are especially well-suited to bond investing because bond markets are relatively large and inefficient compared with stock markets. This creates opportunities for active managers while the ETF structure delivers lower costs.

Unlike passively managed ETFs that seek only to mirror the performance of an index, experienced active managers can analyze all of these factors to help choose which bonds to buy and which to sell in an effort to outperform the index. They can draw on expert researchers and traders to sort through the unique characteristics of bond markets and discover attractive investment opportunities that passive strategies miss. The market price of a bond may not reflect its intrinsic value and active managers can buy bonds they view as underpriced and sell those they deem overpriced. Meanwhile index managers must instead track index exposures with little regard to such fundamentals.

Active bond fund managers can generally choose investments from a broader range of bonds than a passive index fund can, and they may employ investing strategies that could help contribute to improved overall performance, even when interest rates are rising. Even though the Bloomberg US Aggregate Bond Index contains more than 12,000 securities, it represents just a sliver of the $59 trillion bond market. That means an active manager could choose from among far more bonds than could a passive manager of a fund portfolio benchmarked against that index.

Ready for changing rates

The Federal Reserve has raised interest rates to fight inflation, but it's far from clear whether rates will still move much higher. Although bond prices typically change when interest rates do, active bond managers can take advantage of shifts in rates, or hedge against their potential adverse effects. Active managers also can benefit from trading opportunities to help generate returns and manage risks, even as rates rise. The extent of this advantage depends on the quality of fundamental research and quantitative analysis that's available to the manager.

Why ETFs?

Bond investors who want active management for their portfolios can, of course, choose mutual funds as well as ETFs, depending on their individual preferences, so it's good to consider the differences. Both active and passive ETFs are priced throughout the day, unlike mutual funds. That means actively managed ETFs can be traded throughout the day.

Active ETFs typically have expenses that are lower than mutual funds that invest in similar assets but higher than those of most passive ETFs. The higher costs of active ETFs typically reflect the cost of building and maintaining the research and trading capabilities in seeking to deliver higher returns. But while passive ETFs may cost less than active ETFs, they do still charge fees. When those fees are subtracted from a passive ETFs potentially lower returns compared with an active ETF, the difference in returns between active and passive ETFs may be even greater than the difference between the active ETF and the index.

Finding ideas

Maintaining a well-diversified portfolio of stocks and bonds may be as important as ever to help you reach your goals and choosing the right active bond ETF involves some research. Read about Fidelity Active Fixed Income ETFs to learn more.