(Bloomberg Opinion) -- The pitch for an actively managed bond exchange-traded fund can be compelling, especially when there’s market turmoil and uncertainty: Let a pro handpick bonds that can outperform benchmarks instead of investing in an index-tracking fund on autopilot, but pay less than you would for a mutual fund. Oh, and you can save on taxes, too.
More investors are taking the bait. Last year, active ETFs accounted for 14% of overall ETF flows even though they made up just 4% of assets, according to a report from Bloomberg Intelligence analyst Eric Balchunas, who tracks the data. So far this year, more than 30% of incoming flows are to active ETFs. In addition, since 2021, dozens of such funds have been unveiled, including versions from big names like Vanguard Group and JPMorgan Chase & Co.
But a look at performance — when it mattered most — should stop investors in their tracks. Active fixed-income ETFs were a total flop as bonds were hammered by the Federal Reserve’s actions last year and suffered their worst performance on record. Just half of 182 actively managed bond ETFs outperformed their respective indexes, data from Morningstar Inc. shows.
So far this year, they’re proving even more disappointing. About 40% are beating their indexes. More pain is sure to come with bond market volatility climbing toward the highs of the global financial crisis. Take Pacific Investment Management Co.’s $3.3 billion Active Bond ETF. Looking at five-year and one-year performance through March 21, it’s lagged far behind its benchmark, according to data compiled by Bloomberg.
Actively managed corporate bond ETFs, including the ones run by Fidelity Investments and BlackRock Inc, have stumbled over the past year, as have most actively managed municipal bond ETFs. T. Rowe Price’s Total Return ETF and Western Asset’s Short Duration Income ETF have also come up short.
Of course, there are outliers. Fidelity’s Total Bond ETF did slightly better than its index over the past 12 months, and over the past three and five years, it’s significantly outperformed. Other actively managed bond ETFs have also beaten their benchmarks when looking over a longer time horizon.
But if so many active bond ETFs struggled in 2022 — when active management was supposed to provide protection amid rising interest rates — who’s to say they’ll be able to navigate future bouts of bond market volatility more effectively? If anything, the recent (under)performance of active bond ETFs just reinforces why passive is almost always preferred in the fund world.
Putting an active bond strategy in an ETF may help to tilt the odds compared to a mutual fund because it’s cheaper and more tax efficient, but, that’s still not enough. As Morningstar’s Ben Johnson told me: “An active ETF may help to reduce the force of gravity, but it’s not a pair of anti-gravity boots.’’
Plus, an active bond ETF may not even be cheaper than a mutual fund. The average asset-weighted expense ratio among actively managed fixed-income ETFs is 0.49%, according to Morningstar. In comparison, the average expense ratio for all active funds (meaning mostly mutual funds) is about 0.6%. And for bond mutual funds, it’s around 0.4%, the Investment Company Institute says.
For investors who are dead-set on an active ETF strategy for their bond portfolios, the best approach is to focus on a cheap fund (think Vanguard). That way, there’s a lower hurdle to outperform the benchmark.
Last year, investors pulled more than $500 billion from bond mutual funds. The lure of a cheaper form of active management may be a tempting home for some of that money, but don’t be fooled. Index investing is winning out, even when markets are scary.
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To contact the author of this story:
Alexis Leondis at [email protected]