The S&P 500 eked out a gain last week after four straight weeks of losses for stocks, but the market correction has sent many investors running for cover in bonds.
The move into bonds is no surprise given the ongoing market volatility and uncertainty over the impact of President Trump’s policies on the U.S. and global economy this year. But in the world of ETFs, the size of the recent migration into bonds is eye-opening, with bond funds taking in almost as much money as stock funds.
Bond fund inflows of $90 billion in the past month are not far off the $126 billion taken in by equity funds, a “very rare” trend in the ETF world which was the starting point for discussion among fixed-income experts on last week’s CNBC “ETF Edge.”
Two fixed-income categories that have been big beneficiaries of the flight to safety are actively managed core bond funds and short-duration bond funds, including the shortest of U.S. treasuries, “ultra-shorts.”
Ultra-short bond ETFs have gained over 40% of all flows into fixed-income ETFs this year, according to data from ETFaction.com. Actively managed enhanced core bond funds, meanwhile — which seek to outperform the broad corporate bond index, “the AGG” — have taken the lion’s share of the new money from investors in their asset class, five times as much as passively managed enhanced core bond index ETF counterparts, according to ETFaction.
For years of the bull market, as stocks raged and the Federal Reserve pushed up yields in bonds in its fight against inflation, the classic diversified stock and bond portfolio was dead. But Jeffrey Katz, TCW managing director, says the “60-40 portfolio” — 60% stocks and 40% bonds — “is doing its part” again, and that’s despite all the narrative about yields.
During a time of high stock market volatility, “it’s performing as it should,” Katz said on CNBC.
But his bet is that investors will do better by not only investing in bonds, but ditching the AGG and allowing an active manager like TCW to find better than index-matching opportunities to generate excess returns. One place the TCW Flexible Income ETF has been attempting to do that is aligned with the AI boom, where $35 billion in bonds have been issued to fund the construction of AI data centers.
“We have a pretty strong secular tailwind from the AI boom, in addition to some of the cloud storage demand,” Katz said.
TCW’s views is that the corporate credit market as whole is “fully priced,” Katz said.
“Data centers are a new phenomenon, two years of issuance related to AI and the big demand for cloud computing and computing power,” he said.
In addition to being overweight the AI data center bonds, the TCW Flexible Income ETF has made bigger bets on residential single family housing market bonds, a market which in undersupplied and where the level of equity built up in the housing stock limits the risk of default. The TCW ETF has also prioritized commercial real estate in what’s called the Class A market, with the call of workers back to offices leading the “Park Avenue type” to see a strong rebound. “We’ve leaned into that,” Katz said.
The most widely used bond benchmark remains the AGG, the old Lehman Brothers Aggregate Bond Index that is now the Bloomberg Barclays Aggregate Bond Index, and over the long-term, actively managed strategies in both stocks and bonds have struggled to outperform indexes. But Katz said the active approach has been paying off for investors in bonds as active managers can deviate from an outdated AGG approach to bond market representation, with as much as $26 trillion in bond market opportunities that the AGG never touches.
Katz said the TCW Flexible Income ETF has outperformed the AGG since inception in 2018 by nearly 500 basis points, with a return of 6.51% versus 1.82% for the AGG.
“The indices are old and they don’t represent how we trade today,” said Alex Morris, chief investment officers at F/m Investments. “It’s been three decades,” he said on “ETF Edge.”
“Bond indices get bloated with tens of thousands of issuances,” Morris said. “The AGG is so big, it’s un-investable.”
Ultra-short options for inflation and uncertain times
At F/m Investments, another way the bond team is looking to attract investors seeking a safe haven is at the very short-end of the fixed-income market. Investors are skittish on stocks but have too much sitting in cash, Morris said, with over $7 trillion in money market funds and over $18 trillion sitting in bank deposits, “not even CDs, just deposit accounts,” he said.
F/m Investments offer access to short-duration treasury bonds, such as its TBIL ETF, and recently launched an ultra-short ETF, the Ultrashort Treasury Inflation-Protected Security ETF, focused on treasury-inflation protected securities, otherwise known as “TIPS.”
The risk that investors take with bond duration increases during times of uncertainty, Morris said, and may not deliver the safety that investors are seeking from fixed-income, one reason his firm has a focus on shorter duration bonds.
Policies such as tariffs are inherently inflationary, Morris said, “until they become depressionary.”
“They can just destroy growth in a way we don’t want to think about,” he added.
As investors become more concerned about inflation — inflation expectations have been rising again, though the Fed said last week it expects any tariffs impact to be “transitory” — “we like staying short and liquid,” Morris said.
That means treasury issues no longer in duration than two-year and five-year bonds, where “you don’t have to worry about aging out and not trading well.”
TIPS, he says, became “a dirty term for a lot of folks,” but ultra-short duration TIPS are not an area of the bond market that has been represented in the bond fund space and can limit some of the risks that hurt investors in recent inflation history, Morris said.
The short-duration bonds are linked to CPI (the consumer price index), and reset every month to reflect inflation. Investors didn’t get what they expected from TIPS in the recent past, Morris said, because they bought the wrong asset at the wrong time. “People buy when they see inflation coming and that’s how they get burned … that’s when the Fed hikes, and that’s drives duration assets down,” he said. “Even shorter-term tips, even two-, three-year, got absolutely smoked.”
The new F/m ETF holds TIPS with 13 months or less to maturity, and an average duration “well under one year,” according to the firm.
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