There’s ample, long-running criticism of active management and plenty of data points confirm the criticism is warranted. However, those critiques are delivered in broad fashion. To be accurate and fair, some active managers beat their benchmarks and some even do so with regularity.
Still, stock-picking is hard. Really hard. However, some experts believe the fixed income space is more conducive to active management than the realm of stocks. There may be something to that assertion because some corners of the bond market, emerging markets and senior loans being example, can be areas in which clients can benefit from active approaches.
For novice investors, evaluating active management could be pivotal in a treacherous fixed income environment on the basis that an index-based strategy will only deliver the index’s returns minus fund fees while active managers seek returns in excess of a particular benchmark.
Whether they opt for active or passive funds, advisors and clients may want to put renewed emphasis on fixed income exchange traded funds because of a big advantage over mutual funds: Lower fees.
On Fees, Bond ETFs Win
Funds, be they active or passive, ETF, index or mutual, carry fees. For long-term investors, which are the target end users for bond funds, fees are of the utmost importance. The reasoning is simple: The longer an investor holds a fund, the more fees add up and eat away at returns. So the lower the better when it comes to fund fees, regardless of underlying asset class.
For advisors looking to make headway in terms of fixed income fund fees, the answer is clear. Data confirm ETFs carry the day – both active and passive.
“Fees for bond ETFs are 60% lower than their mutual fund peers. Bond ETFs’ median net expense ratio is just 0.28% versus 0.70% for mutual funds,” according to State Street Global Advisors (SSGA). “Active fixed income ETFs’ median net expense ratio is 0.40% versus 0.71% for active mutual fund peers.”
SSGA isn’t just talking the talk. It’s walking the walk. On Aug. 1, the third-largest U.S. ETF sponsor announced expense ratio reductions on 10 ETFs, a quartet of which are bond funds. Separately, some advisors may be interested to know that many ETF issuers work with active bond managers on select ETFs and those funds usually carry smaller expense ratios than mutual funds. That’s true with SSGA.
“SPDR works in partnership with renowned active fixed income managers like DoubleLine, Blackstone Credit, Nuveen, and Loomis Sayles to offer investors access to a range of skilled active portfolio managers,” adds the ETF sponsor.
Remember Total Cost of Ownership
Many clients are already familiar with ETFs, but what they may not be familiar with is total cost of ownership (TCO). In simple terms, TCO on is ETF’s expense ratio plus its holding and trading costs.
As advisors know, TCO applies to mutual funds, too. However, this is another case of ETFs winning the battle and that’s good news for clients. Capital gains prove as much.
“ETFs are tax efficient because they tend to distribute fewer capital gains than mutual funds. In 2022, just 3% of fixed income ETFs distributed capital gains compared to 15% of fixed income mutual funds,” concludes SSGA. “Taking a broad view, 4% of all ETFs distributed capital gains compared to 44% of mutual funds.”
Related: Preparing Clients for 2024 Elections