Investors pivot to bond ETFs for liquidity and resilience as the Fed’s next move remains unclear
Bond ETFs are pulling in record sums as investors, seeking stability and liquidity, recalibrate their portfolios amid shifting interest rate expectations and a cloudy economic outlook.
According to Morningstar Direct, fixed-income ETFs attracted nearly US$344bn through October 31 this year, more than double the US$138bn that flowed into fixed income mutual funds.
In October alone, mutual funds saw US$74bn in outflows, while ETFs drew in US$166bn.
This surge is fuelled not only by the proliferation of new bond ETF offerings—especially actively managed funds—but also by their perceived advantages: lower costs, tax efficiency, and the ability to trade throughout the day, as reported by CNBC.
Dan Sotiroff, senior analyst for passive strategies research at Morningstar, emphasized the critical role bonds play as a ballast in diversified portfolios.
“You have to remember the role of bonds in a portfolio,” said Sotiroff. “It’s usually to serve as a ballast — and how big of one is something you have to sort out on your own or with your advisor.”
He noted that active management in bond ETFs “has a legitimate edge,” with managers able to “bring something different to the equation and have a shot at outperforming their benchmark.”
Morningstar data shows the number of actively managed bond ETFs (511) now exceeds passive ones (393), though the former come with higher expense ratios—0.35 percent on average, compared to 0.10 percent for passively managed funds.
Yet, the safety of bonds is not absolute.
As Tim Videnka, chief investment officer at Forza Wealth Management, cautioned, “The year 2022 showed you can lose money in the bond market. People can sometimes forget what can happen when there’s real fear.”
When the US Federal Reserve raised rates to combat inflation, bond prices slumped, resulting in major losses for bond indexes.
Videnka stressed the need for liquidity and quality, especially for those relying on bonds to fund living expenses.
The current environment is marked by uncertainty around the US Federal Reserve’s next move.
As reported by Bloomberg, the cancellation of the October US employment report due to a government shutdown has left policymakers and investors without a crucial data point ahead of the Fed’s final meeting of the year.
The market’s odds of a December rate cut have dropped to about 30 percent, down from roughly 50-50 before the announcement, as swap contracts linked to the Fed policy rate now heavily favour keeping rates steady at 3.75 percent to 4 percent.
Morgan Stanley economists noted, “This lowers the chances of a December rate cut. An easing labour market is the key argument for a December rate cut.”
Economists surveyed by Bloomberg expect US payrolls to increase by 51,000 in September, with the unemployment rate forecast to remain steady at 4.3 percent.
Ed Al-Hussainy of Columbia Threadneedle Investments pointed out that a stable US unemployment rate would signal no need for further economic stimulus, while even a slight uptick could indicate the US economy needs more support.
