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Experts believe that fixed income is no longer the part of your portfolio that you can leave alone, due to rising interest rates and uncertainty in the global economy.iStockPhoto / Getty Images

Passive fixed-income ETF investing has long been counted on to offer steady returns at low cost, with inherently less risk. But rising interest rates and uncertainty in the global economy are bringing complexity to this passive approach and affecting its ability to generate yield.

Active management can help achieve fixed-income goals and objectives in this turbulent environment, says Ahmed Farooq, vice-president of ETF business development at Franklin Templeton Investments. Actively managed fixed-income ETFs are growing vastly in popularity, he notes, and bringing results that justify these rising numbers.

“Fixed income is no longer the part of your portfolio that you can leave alone and walk away,” Mr. Farooq says. Fixed-income investments have been traditionally considered a “safe haven,” he says; however, with rate hikes and geopolitical turbulence, they may expose investors to unintended risks and have “started becoming a thorn in the backs of advisers,” who are looking for alternatives.

Franklin Templeton offers four actively managed ETFs, including its FLGA - Franklin Liberty Global Aggregate Bond ETF (CAD-Hedged), which was launched last May and today has $360-million in assets and growing. These products have management fees of 0.35 to 0.45 per cent, comparable to passive fixed-income ETFs, and are backed by solid portfolio managers with long track records and high ratings.

Mr. Farooq says the problems with passive funds, which measure broad exposure to a particular market, include their duration, which can’t change as interest rates vary and may leave investors poorly positioned. There is also no flexibility to adapt to market fluctuations like the Brexit controversy and U.S. trade war jitters in the last quarter of 2018. “You can’t dial up and dial down the risk,” he comments. “Passive is passive; there are no active calls; you mirror the fundamentals of the index.”

Ahmed Farooq

A major reason forthe popularity ofactively managedfixed-income ETFsis that they canrespond to marketconditions, asopposed to waitinguntil the indexmakes changes.

Ahmed Farooq, vice-president of ETF business development at Franklin Templeton Investments

The fact that actively managed fixed-income ETFs can achieve several goals, from high coupons to varying durations, has made them increasingly attractive given the unknowns in the market, he says. According to National Bank of Canada ETF Research and Strategy, the one-year growth of assets under management in actively managed fixed-income ETFs was 46 per cent as of December 2018, while passive fixed-income ETF asset growth was just 2 per cent for the same period. The 10-year annualized growth in assets under management of all fixed-income ETFs was 35 per cent as of December 2018. The growth rate of active fixed-income ETFs was 81 per cent, while the growth rate of passive ones was 31 per cent.

A major reason for the popularity of actively managed fixed-income ETFs is that they can respond to market conditions, as opposed to waiting until the index makes changes, Mr. Farooq explains, and the results are favourable. Morningstar reports that in a comparison of rolling one-year returns over the last 24 months, actively managed fixed-income ETFs outperformed the FTSE Canada Universe Bond Index 83 per cent of the time.

How do active and passive investing strategies compare in terms of risk? “There’s risk on both ends,” Mr. Farooq says. “At the end of the day, what does the client want from that part of their portfolio?”

He notes that “in this environment, it makes a lot of sense to go active,” although passive fixed-income ETFs may still have their place for investors, depending on their exposure, the market cycle and what is going on in the world.

“For every part of the portfolio, you’ve really got to pull out that pie and decide what investments should be there,” Mr. Farooq adds, perhaps including both active and passive approaches. “It’s not one or the other, it’s how do I complement them into my portfolio?”


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