Why investors need both active and passive in a modern fixed income portfolio

Daniel Stanley from BMO ETFs shares his top tips for constructing a fixed income portfolio

Why investors need both active and passive in a modern fixed income portfolio

With the spread between the best and worst performing North American active bond fund being only 1.5% *, advisors would be wise to seriously consider passive bond ETFs for their domestic fixed income exposure.

Investors are growing increasingly aware of the impact of fees on their fixed income investments and, consequently, passive ETFs are attracting more investor money. With a 1.5 % spread, it is easy to forecast how management fees could eat into returns.

“If you are investing in domestic Canadian bonds, it makes more sense to budget your management fees to a low-cost, passive bond ETF, instead of an active fund,” said Daniel Stanley, Director, BMO ETFs.

However, Stanley is quick to note that moving to a passive fixed income strategy depends on how comfortable investors are with making educated decisions in the bond market. For Stanley, it comes down to both the advisors level of conviction and the type of business they have built.

“There are a number of advisors out there that have built their practices around actively managed mutual fund solutions, and that’s good,” he said. “The reality is that some advisors are just more comfortable doing that.”

When it comes to options for investors who are looking for low cost North American Bond ETFs, Stanley’s recommendation is ZAG, BMO Aggregate Bond Index ETF. Investors in the ETF are buying corporate bonds, government bonds, short-term bonds, mid-term bonds and long-term bonds, all for a knock down price of eight basis points.

“It is both the lowest cost bond ETF in Canada and the largest bond ETF in Canada,” Stanley said. “There is roughly $3.5 billion in that ETF right now, so you can see why it is attractive.”*

Its low cost isn’t ZAG’s only differentiator. It has also performed well, beating 70% of active managers in the marketplace last year*. “There is a lot of uncertainty out there in the environment but ZAG has done very well,” Stanley said. “ZAG holds short-term bonds as well as some long-term bonds, which can offset each other under different interest rate environments.”   

While advisors may struggle to see the value in active management in the domestic bond market, the same cannot be said for global and high yield bonds. The spread between the best and worst performing global fixed income ETFs is around 3%, and in the high yield sector the differential is closer to 5.5%.

“There are more levers for active managers to pull in global and high yield fixed income,” said Stanley. “First and foremost, these markets tend to be less efficient, less covered, so there is room for a good credit manager to analyze companies and pick the bonds that are underpriced.”

In response to the need for active management, BMO GAM has launched three different ETFs for Canadian investors. The BMO Core Plus Bond Fund ETF Series (ZCPB) combines both domestic and global fixed income, while the BMO Global Multi-Sector Bond Fund ETF Series (ZMSB) is a diversified portfolio of investment grade bonds, government bonds, high-yield bonds, emerging market bonds and securitized debt. It rotates between sectors when the assessment of value changes.

“The third one, BMO Global Strategic Bond Fund ETF Series (ZGSB) is managed by PIMCO,” Stanley said. “It has an actively managed, multi-sector approach and holds U.S. investment grade and global high yield bonds and debentures, and emerging market debt It is designed to achieve better long-term risk-adjusted returns for investors.”

*Source: BMO Asset Management Inc. All data as of June 30th, 2018

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