Points to Consider When Buying an Active Bond ETF

In the world of ETFs, actively managed fixed income is undoubtedly one of the fastest-growing segments. Indeed, the union of the ETF wrapper and bonds breathes fresh life into active management. Count the ALPS/SMITH Core Plus Bond ETF (SMTH) among the ETFs contributing to what’s now a lengthy, sturdy trend.

Looking at the particulars, this intermediate-term ETF is just over two years old. Already, it has nearly $2.5 billion in assets under management. That confirms that advisors are finding value in the fund as an alternative to traditional passive aggregate bond exposures. Of course, advisors and income investors should do some homework before embracing SMTH, or any other active bond ETF.

For example, the average fee on active bond ETFs is predictably higher than on equivalent passive products. Believe it or not, there may be positives in that scenario, including motivation for active managers to “earn their keep.”

“[Cost] compression among passive ETFs in safer and simpler categories like intermediate core and intermediate core-plus bond makes it difficult for active managers to compete on fees,” noted Morningstar analyst Lan Anh Tran. “Active ETFs in these categories must offer even more of an advantage for the investment to be worthwhile.”

SMTH May Be a Better Bet

One of the perks of SMTH’s active management is that, though not guaranteed, human oversight can potentially generate outperformance. Passive bond ETFs contend with limitations active managers can avoid.

“Active bond managers have a better chance of beating their passive peers than active equity managers, according to Morningstar’s Active/Passive Barometer. “While their success rate only hovers around 50% for longer periods, active bond managers have more tools at their disposal to deliver excess returns,” added Tran.

In many cases, active bond managers, particularly those overseeing aggregate strategies, generate outperformance by taking on more risk than passive rivals. That’s not necessarily the case with SMTH. At the very least, the ALPS ETF isn’t excessively risky in terms of credit quality. Two-thirds of the ETF’s holdings are rated AA or A. Meanwhile, just 9% carry junk ratings of BB or B.

“Active bond ETF outperformance typically comes with higher risk,” concluded Tran. “A good active manager can make sure investors are well compensated for it. Choosing an experienced management team with a consistent track record, especially through market stress, should serve investors well.”

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