When it comes to assessing actively managed fixed income exchange traded funds, advisors have a lot on their plate and that plate is getting heavier.
For years, the active bond ETF evaluation process was mostly limited to standalone products, but amid a spate of mutual fund-to-ETF conversions, advisors have a fresh set of considerations and that due diligence is going to increase as more issuers introduce ETF share classes of established mutual funds.
Advisors need not fret because the evaluation process for active bond ETFs with roots in the mutual fund world isn’t as daunting as it appears at first glance. The evaluation process should start with assessing what type of relatives are the ETFs and mutual funds in question – siblings, twins or merely cousins?
If the answers are “cousins” or not related at all, advisors can assess the deviations between the two products and how those deviations could affect the ETF’s long-term performance. Overall, the process isn’t “crazy. ”
More Tips When Moving From Mutual Funds to Bond ETFs
When evaluating fixed income ETF equivalents or offshoots of mutual funds, advisors and investors may want to examine Morningstar approach of parent, people, performance, price and process. In this case, parent, people and process are most meaningful because end users want to know if the active bond ETF is managed by the same folks and adheres to similar methodology as the equivalent mutual fund.
“Portfolio management team, philosophy, process, exposures, and risk-budget may all differ between the ETF and mutual fund,” observes Vanguard. “This is the first thing to check to ensure the ETF is actually an equivalent product. Any differences in these categories can create meaningful performance differences from the mutual fund and require a fresh approach to due diligence. ”
Parent considerations largely revolve around an issuer’s established competencies in operating ETFs. Obviously, every sponsor has to have a first ETF, but many advisors and investors don’t want to be in the test group. They prefer experience and it’s their right to feel that way.
“There are material differences in operating ETFs and mutual funds, including those highlighted here,” adds Vanguard. “ETFs require a different set of operational requirements than mutual funds, and those requirements take time, expertise, and experience to master. Make sure your provider has a track record in this space. ”
Trust, But Verify
“Trust, but verify” is actually an old Russian proverb, making it interesting that rose to prominence via President Ronald Reagan and to this day, the saying is largely attributed to him. Fun facts aside, the saying is pertinent in evaluating active bond ETFs with mutual fund ties. Put simply, verifying exactly how comparable the two products are can help avoid disappointment and set reasonable expectations for long-term performance.
“As ETF adoption accelerates, the temptation to swap a mutual fund for its ‘equivalent’ ETF will only grow,” concludes Vanguard. “But don’t assume equivalence—verify it. Make sure the ETF is managed by the same team, follows the same philosophy, and is backed by a provider with proven expertise in fixed income ETF management. ”
