Investment-Grade Bonds: Rethinking Stability and Security

Investment-grade bonds have long been considered a reliable option, offering attractive yields ranging from 4% to 5%. However, recent market conditions have challenged their reputation for stability and security. Bond prices are susceptible to fluctuation when interest rates rise, and the past two years have seen particularly volatile rate movements.

Take the iShares Core US Aggregate Bond ETF (AGG), for example. With assets totaling $101 billion, this ETF tracks the main investment-grade bond index. In 2022, it experienced a significant decline of 13%. The following year, it rebounded with a gain of 5.7%. However, as of now, it is down 1.3% year to date, according to Morningstar data.

Given the current climate in fixed-income markets, it may be prudent to consider active management. Unlike passive approaches, active management allows a professional portfolio manager to navigate various credit and interest-rate risks by making timely adjustments to the bond holdings. This strategy aims to minimize losses while providing upside potential and a consistent yield. Morningstar reports show that since 2022, active bond funds have outperformed their passive counterparts—an indication that this might be the "golden age" of active bond investing, as stated by David Leduc, CEO of Insight North America.

Despite these compelling arguments for active management, many advisors appear to prefer actively managed fixed-income mutual funds over exchange-traded alternatives. Capital Group's research reveals this trend among advisors, even though they launched a suite of six active bond ETFs in 2022. Other major asset management firms such as BlackRock, Pimco, and Vanguard have also introduced active fixed-income ETFs within the last year.

In conclusion, while investment-grade bonds continue to offer enticing yields, their history of stability and security may no longer hold true in today's market environment. As investors seek to navigate the ups and downs of interest rates, active management approaches become increasingly relevant. The allure of actively managed fixed-income mutual funds remains strong among advisors, despite the growing availability of active bond ETFs from reputable asset management companies.

Capital Group Sheds Light on the State of Active Fixed-Income ETFs

According to research conducted by Capital Group, a staggering 80% of assets in fixed-income mutual funds were actively managed as of the end of last year. In contrast, only 12% of assets in fixed-income ETFs followed the same approach. Holly Framsted, the head of Global Product Strategy and Development at Capital Group, attributes this discrepancy to limited supply, prompting the need to uncover the underlying factors at play.

To gain deeper insights, Capital Group conducted a survey involving 400 financial professionals last fall. The results revealed that less than 4% of funds managed by advisors were allocated to active fixed-income ETFs due to a lack of awareness and understanding of their advantages.

The structuring of ETFs offers numerous benefits compared to open-end mutual funds. Some of these advantages encompass lower overall costs, increased liquidity, potential tax benefits, and improved return possibilities for bonds through more active strategies.

Moving forward, Capital Group aims to embark on an educational journey to help financial advisors fully appreciate these benefits. Younger advisors, specifically those aged 30-39, demonstrated a higher level of knowledge regarding active fixed-income ETFs compared to their older counterparts.

Moreover, independent advisors exhibited a greater familiarity with fixed-income ETFs in comparison to advisors at large brokerage firms or wirehouses. Advisors in the wirehouse channel allocated the smallest amount of assets to active bond ETFs when compared to advisors at independent, bank, and regional firms.

In conclusion, the study conducted by Capital Group has shed light on the current state of active fixed-income ETFs. As an increasing number of financial professionals become aware of the advantages these investment vehicles offer, it is expected that their popularity and usage will subsequently rise.