The opportunity for active managers is fueled by interest-rate volatility
and market reactions to central bank announcements, plus inflation and
economic growth expectations. We have exited a long period of declining
rates, and can now expect return differences across sectors and issues as
bond markets adjust to the tightening regimes.
As well, since bonds trade over the counter, fixed income markets lack the
transparency of exchange trading, increasing the potential of active
management. The Canadian market is focused on investment-grade government
and corporate bonds, so active managers can add value not just in
traditional markets, but by adding high yield bonds, looking across
geographies and investing in securitized debt.
At the same time, the traditional benefits of ETFs remain in place:
diversification; transparency; and enhanced liquidity. Typically, active
fixed-income ETFs have been at the forefront of lowering the cost of active
investing. These ETFs then combine the benefits of ETFs with active
Placed alongside passive ETFs, these new active ETFs add value through
investing outside of traditional benchmarks and finding pockets of
undervalued bonds. How to best use active ETFs? We view active and passive
as complimentary, where depending on an investor’s approach, active,
passive, or a blend can be effective ways to build a portfolio.
The simplest decision tree puts the emphasis on passive for fee-conscious
investors and active for investors looking for outperformance. Just as
important is an investor’s level of conviction in the markets, or their
confidence in their views. An uncertain investor will favour the use of
active managers to make allocation decisions, where a high conviction
investor will want to pick their own passive building blocks around yield
curve, credit, and currency views.
Investors can build portfolios around their view of the economy, where an
optimistic view will favour corporate bonds in anticipation of narrowing
credit spreads. As well, views on the yield curve, where short-term bonds
are most impacted by central bank policy and long term bonds move with the
economic cycle and inflation, can dictate portfolio positioning using ETF
The ETF’s exposure also counts, where a traditional, domestic
investment-grade manager will not have the same active opportunities as a
global, multi-sector manager, unless the domestic manager can invest
outside of their benchmark. Security selection is less impactful on bonds
than equities, so credit, curve, and sector decisions drive fixed income
Looking at the past three years, confirmation comes from the returns by
category, where the dispersion in Canadian Fixed Income at 1.6% annually,
falls short of the dispersion in Global Fixed Income and High Yield Fixed
Income, at 3.0% and 5.1% respectively.*
Within Canada, taking concentrated portfolio decisions can drive
performance, where splitting the investment grade universe by credit and
term significantly drives performance. As shown in the table below, the
dispersion in the three-year return between short federal bonds, at 0.2%
annually, and long corporate bonds, at 5.5%, has a 5.3% performance spread.
BMO ETFs recently launched three active fixed income ETFs to help build
BMO Core Plus Bond Fund (TSX: ZCPB)
BMO Global Multi-Sector Bond Fund (TSX: ZMSB)
BMO Global Strategic Bond Fund (TSX: ZGSB)
Adding active fixed income ETFs can add outperformance to portfolios, used
wisely by adding off-benchmark investments, making curve and credit
decisions, and investing in global sectors that are more developed than in
Canada. Working together with passive fixed income ETFs, blended portfolios
offer meaningful differentiation across interest rate curves and credit
while keeping a focus on low cost.
* As of June 30, 2018. The returns are winsorized to remove top 10% and
bottom 10% of funds. Returns based on all Series F funds within each
specified Morningstar fund category.
Mark Raes is Head of Product, ETFs and Mutual Funds, BMO Global Asset
This article first appeared in the Fall 2018 issue of
Your Guide to ETF Investing, published by Brights Roberts Inc. Reprinted with permission.
Notes and Disclaimer
BMO Global Asset Management is a brand name that comprises BMO Asset
Management Inc., BMO Investments Inc., BMO Asset Management Corp. and BMO’s
specialized investment management firms. BMO ETFs are managed and
administered by BMO Asset Management Inc., an investment fund manager and
portfolio manager and separate legal entity from the Bank of Montreal.
Commissions, management fees and expenses all may be associated with
investments in exchange traded funds. Please read the ETF Facts or
prospectus before investing. Exchange traded funds are not guaranteed,
their values change frequently and past performance may not be repeated.
®BMO (M-bar roundel symbol) is a registered trade-mark of Bank of Montreal.
© 2018 by BMO Asset Management. All rights reserved. Reproduction in whole
or in part by any means without prior written permission is prohibited.
Used with permission.