The U.S. exchange traded funds industry will forever be rooted in equities. At least in terms of history because the SPDR® S&P 500® ETF Trust (NYSEARCA:SPY) was the original ETF to list in the U.S.
However, fixed income ETFs have long been a fixture on the ETF scene as well. Today, bond ETFs trading in the U.S. have a combined $1.2 trillion in assets under management, confirming the asset class has come a long way since its inception in 2002.
For what felt like generations, actively managed fixed income funds dominated this landscape. Over that time, advisors and investors embraced the combination of active management and bonds with some market participants simply assuming there was no other way. Of course, index funds and ETFs altered that thinking, but that doesn’t mean advisors have to forsake the benefits of active management.
In fact, many of the largest actively managed ETFs are bond products, some of which are ETF offshoots of established, popular mutual funds. However, there’s more to the story.
Bond ETFs Beat Mutual Funds on Multiple Fronts
With active management not only possible, but highly popular in the fixed income ETF space, mutual funds have real competition on their hands and fees are another reason why that’s the case.
“With a median net expense ratio of just 0.29% versus 0.61% for fixed Income mutual funds, fixed income ETFs are, on average, 52% lower cost than their mutual fund counterparts. The median net expense ratio for an active fixed income ETF is also lower versus its active fixed income mutual fund peer, 0.40% vs 0.63%,” according to State Street Global Advisors (SSGA).
It’s possible that mutual funds will eventually drive fees lower to match those of ETFs. Even if that happens, it will take years. One thing that cannot be conquered is the point that ETFs – equity or fixed income -- or inherently more tax efficient than mutual funds due to the creation/redemption process, which leads to lower distribution of capital gains by ETFs.
“While both ETFs and mutual funds must distribute any capital gains to shareholders at the end of each year, decreasing their return on investment, ETFs generally distribute fewer capital gains. The improved tax profile for ETFs is a result of the tax efficient in-kind redemption process used to meet shareholder redemptions,” adds SSGA.
The structure of mutual funds doesn’t offer those tax benefits and that’s meaningful because as SSGA notes, in 2021, 23% of bond ETFs distributed capital gains “compared to 42% of mutual funds.”
True Across Multiple Fixed Income Asset Classes
Certainly, advisors should expect lower fees on aggregate bond ETFs, even if they’re actively managed. However, the fee advantage holds true across an array of fixed income segments.
Advisors can peruse a variety of bond segments – corporates, municipals and even more exotic fare –and find lower fees with tax benefits.
“With elevated volatility in both equity and fixed income markets amid a restrictive Federal Reserve and persistent inflation, we expect strong flows into low-cost, tax-efficient ETFs to continue. As their benefits become more broadly explored and understood, fixed income ETFs will continue to increase in number and variety, creating greater application opportunities,” concludes SSGA.