In the wake of hints that rate rises are finally in the economic rear-view mirror, investors are turning their gaze toward fixed income ETFs, instruments that have shone in times of previous rate easing, as they look for a cushion against volatility and a competitive edge in the investment landscape.
“Historically, fixed income ETFs have performed quite well in terms of providing relatively quick and easy access to financial markets via an exchange especially when investors believe an interest rate easing cycle is looming,” says Ron Mehmet, portfolio manager at Lonsec Investment Solutions, part of the Lonsec Group.
It became increasingly clear in November last year that central banks are gaining comfort with the trajectory of inflation, says JP Morgan. iStock
In easing environments, the strategic allocation of fixed income ETFs has been a cornerstone for portfolios, presenting investors the prospect of regular income and capital appreciation. Together with daily liquidity on a listed exchange, fixed income ETFs have been pivotal in navigating the choppy waters of change.
The changing economic landscape is moving faster than ever, with more complexity for investors to navigate. This unpredictability has made traditional indicators less reliable, prompting investors to consider more tactical adjustments in their portfolio mix.
“Fixed income ETFs are an ideal vehicle to quickly raise your allocation to a bond fund that also includes a focus on the direction of interest rates to add capital gain value (bond prices rise and yields fall) to an investor’s diversified portfolio,” Mehmet says.
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Active markets call for active strategies, even for ETFs
In the ETF space, the debate between active and passive management becomes pronounced in periods of rate adjustments. Active managers have the ability to actively respond to economic shifts and policy commentary, potentially optimising for capital gains, he says.
“In a volatile market, active bond management allows the portfolio manager to adjust their portfolio much quicker at the coal face as economic indicators turn and central banks change their rhetoric on interest rate policies,” says Mehmet.
Ron Mehmet, portfolio manager at Lonsec Investment Solutions.
Unlike their equity counterparts, the composition of bond indices is driven by the largest issuers – not necessarily the highest quality issuers. This means a passive fixed income ETF will automatically drift towards the largest issuers over time irrespective of the quality of their balance sheets. By contrast, an actively managed fixed income ETF can shift allocation towards higher-quality issuers and away from those that could be at risk of rating downgrades. Such dynamic allocation can help mitigate risks and buoy returns in times of economic or market stress.
When evaluating the performance of active fixed income ETFs, it’s important to look beyond mere returns. Comparisons to relevant fixed income indices or passive ETFs over appropriate investment horizons provide a clearer picture, especially when considering risk-adjusted outperformance.
One example of an active fixed income ETF where the manager has the flexibility to make tactical allocations is the JPMorgan Global Bond Active ETF (Cboe: JPGB).
JPGB seeks to optimise its portfolio by dynamically adjusting to changing market conditions, potentially offering investors attractive risk-adjusted returns compared to passive strategies that simply track an index. JPGB demonstrates how active management can add value in the fixed income space, especially during periods of volatile markets.
Managed by J.P. Morgan Asset Management’s Myles Bradshaw, JPGB has been at the forefront of adapting to the expected new economic phase.
Fixed income opportunities in a soft landing scenario
With a proactive stance on the Federal Reserve’s policy changes, JPGB has been fine-tuning its portfolio to harness fixed income opportunities while managing credit and duration risks that could emerge on the back of a highly fluid macro-outlook.
“It became increasingly clear in November last year that central banks are gaining comfort with the trajectory of inflation,” says Bradshaw.
“With higher possibility of a soft landing and expectation of lower bond implied volatility, we added duration while remaining positioned for steeper curves and increased conviction to investment grade credit, agency mortgage-backed securities, European periphery, and supranational bonds.”
Another hallmark of JPGB’s strategy is its disciplined risk management approach. “Our risk management framework is an integral part of our investment process,” Bradshaw says. “It’s a rigorous and repeatable process based on communication and a common research framework.”
The strategy is backed by a multi-layered risk management process leveraging fundamental, quantitative, technical inputs to manage risk while driving performance across market cycles. This approach is complemented by a collaborative process that involves regular discussions across macro, strategy and sector teams,” says Bradshaw.
“Views are debated and challenged, assumptions articulated, catalysts identified and risks measured.”
JPGB’s active management and flexibility have led to an outperformance of the benchmark since inception by 1.04 per cent, a testament to the active ETF’s focus on quality fixed income assets with at least 80 per cent invested in investment grade bonds.
“We actively manage sector allocation, security selection, duration or yield curve management, currency, and hedging,” says Bradshaw.
“As the narratives changed in 2023, our positioning changed from overweight duration, to trimming the longs and down to a neutral stance when we were moving towards ‘higher for longer’, and finally overweight due to expectation of rate cuts towards the end of the year,” says Bradshaw.
Overweight in quality
The fund is now overweight in high-quality spread sectors, anticipating these will benefit from the projected soft landing. With exposure to a broad range of IG fixed income securities, JPGB is diversified across sectors and markets. This helps the strategy achieve strong risk-adjusted returns.
“Bonds have historically outperformed cash after peak in Fed funds rates and central banks have been very clear in messaging they are done hiking rates for this cycle,” says Bradshaw.
“We believe a combination of attractive carry and prospects of capital appreciation as we approach the easing cycle, makes the risk-reward very attractive for bonds going ahead.”
JPGB has been successful in adapting to changing markets, including both rising and falling rate environments. The strategy has been seeing consistent inflows as long-term investors look to lock in the attractive yields.
“Still, the current cycle is very different as central banks are signalling rate cuts due to the progress on inflation, it is important for investors to maintain a quality bias,” Bradshaw says.
J.P. Morgan Asset Management’s Myles Bradshaw.
JPGB was listed on Cboe in November 2023 but the strategy it employs has been honed since 2009, demonstrating a long-standing commitment to performance through various economic cycles, says Bradshaw.
The growing trend in active fixed income ETFs
The appeal of fixed-income ETFs stretches across demographics, resonating particularly with a younger, tech-savvy investor base, says Lonsec’s Mehmet.
Bradshaw agrees and adds “The beauty of a fixed income ETF is the fact that we make global fixed income investing simple – it’s efficient, tradeable, flexible and the active element means there is professional oversight.”
“We are also seeing relatively younger investors preferring to use ETFs than the traditional way of investing in fixed-income securities as it aligns better with the technologies of the day,” says Mehmet.
This alignment with technology and accessibility has broadened the reach of fixed-income ETFs, ensuring their relevance in modern investment strategies.
Mehmet says that investors must carefully consider their individual circumstances.
Factors such as risk profile, investment horizon, liquidity needs, and management fees are crucial when assessing suitability.
“Investors should weigh their own risk tolerance and investment goals when choosing fixed-income ETFs,” Mehmet says.
For more information about J.P. Morgan Asset Management’s Fixed Income ETFs, please visit JP Morgan.
