Fixed-income ETFs and portfolio positioning
ETF flows, including in fixed income, continue to thrive, highlighting the role these products can play in an investor’s portfolio.
Since March 2022, when the Bank of Canada began raising interest rates, ETFs have had only two months of negative flows, said David Stephenson, director of ETF strategy with CIBC Asset Management, in a recent interview.
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“As of mid-September, the Canadian ETF industry has seen $44.7 billion in flows year-to-date, which would be the second-best annual flow ever,” Stephenson said.
Fixed-income ETFs account for about $15 billion of flows so far this year, and total assets in the category are about $137 billion, “or 30% of the ETF industry,” Stephenson said.
Most fixed-income categories have seen positive net flows, with Canadian aggregate bonds and corporate bonds leading the way.
Fixed-income flows have been more broad-based this year, Stephenson said, “unlike the last two years, where money market and high-interest savings account ETFs were the notable standouts.”
When choosing between active and passive bond ETFs, Stephenson said investors should consider what the fixed-income allocation is for: liquidity, capital preservation, higher yield, diversification or as an equities hedge.
Active management can provide opportunities to outperform the index and better preserve capital depending on market conditions, he said, while passive ETFs may be more cost-effective.
“On the index side, an investor can buy the Canadian bond market in one trade for as low as six to seven basis points,” he said, whereas the global bond market costs about 20 basis points.
“These are great exposures to anchor most investor portfolios,” he said.
Investors can also use index fixed-income ETFs to “implement active decisions, gain more precise exposures, customize client portfolios, hedge risk, or even capture opportunities,” he said. For example, an emerging-market debt ETF could be used to capture higher yield.
On the other hand, active managers have flexibility to adapt to market changes and can leverage opportunities in the $140-trillion global bond market.
“There are different levers active managers can pull to add value and reduce risk,” Stephenson said, such as adding credit duration in a declining rate environment or adding U.S. high yield as opportunities arise.
Stephenson said he believes fixed-income ETFs will continue to grow as a category for three reasons.
First, demand for yield remains strong.
“Investor demand for yield has been a secular trend that is still intact,” he said.
And despite the easing cycle, bond yields remain at levels not seen since 2008.
“With further rate cuts and inflation coming back down to 2%, flows into fixed income can benefit from still decent yields, plus a better chance of capital appreciation,” Stephenson said.
Second, the increased use of ETFs by both retail and institutional investors is driving growth.
“ETFs provide liquid access to different corners of the fixed-income market, and as product choice has grown, investors use ETFs to pivot quickly, add exposures or shift portfolio sensitivities in only one or two trades,” he said.
Finally, product innovation, particularly in active fixed income, will continue to attract investors, Stephenson said. About 55 new fixed-income ETFs have launched this year, he noted, including those with covered-call options, for example. Another innovation is all-in-one fixed-income products.
As far as the market risk outlook, Stephenson said monetary policy is top of mind.
“Some market participants believe the Bank of Canada needs to lower rates faster and further to avoid a recession,” he said.
The Canadian housing market is another concern, as a large proportion of mortgages come up for renewal over the next three years, with significant payment increases expected. Additionally, geopolitical tensions and the upcoming U.S. election could influence markets.
Regardless, Stephenson’s advice to investors is to stay diversified and stick to a long-term strategic asset allocation plan.
“This is the best way to deliver on financial goals and is a time-tested strategy,” he said.
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