The Limits of Passive Fixed Income Investing | ETF Trends

While parking a client’s assets in index funds may seem like the safe choice, there are some challenges with the passive approach — especially within the fixed income space. Since companies can issue multiple bonds with varying maturities, coupons, and credit ratings, that can increase the number of tradable bonds — and number of constituents — in a broad market index. For passive ETFs tracking these securities, this can pose some difficulties, according to Morningstar.

For one thing, newer index funds with limited assets may not be able to hold all of the constituents in the index. Another issue is that the costs associated with trading all of the securities in a bond index can be prohibitive — certainly more than for an equity index.

So, portfolio managers must constantly weigh the benefit of owning an index constituent against the cost of executing the trade. Meaning, most bond funds leverage stratified or representative sampling instead of full replication. This is why no fixed income ETF is truly passive.

“Degrees of active management even exist in index funds, particularly with regard to fixed-income strategies,” wrote Lan Anh Tran, a manager research analyst for Morningstar Research Services.

Neil E. Kays, senior product marketing manager at T. Rowe Price, shared this sentiment. “Fixed income ETFs almost always have an element of active decision-making,” Kays said. “So, in some areas, there’s even greater opportunities for active alpha.”

For fixed income investors looking for yield, it may make sense for some clients to pursue an active approach to their fixed income investments. It may also make sense to seek out an active manager with the resources to benefit from economies of scale, which often translates to better returns.

“Active managers have the flexibility to take advantage of market volatility and add to favored positions when prices become more attractive,” said Todd Rosenbluth, head of research at VettaFi.

As part of its lineup of active exchange traded funds, T. Rowe Price offers a suite of actively managed fixed income ETFs, including the T. Rowe Price QM U.S. Bond ETF (TAGG), the T. Rowe Price Total Return ETF (TOTR), the T. Rowe Price Ultra Short-Term Bond ETF (TBUX), and the T. Rowe Price U.S. High Yield ETF (THYF).

T. Rowe Price has been in the investing business for over 80 years, conducting field research firsthand with companies, utilizing risk management, and employing a team of experienced portfolio managers carrying an average of 22 years of experience.

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