Has it really been a year? The Federal Reserve Bank of New York announced it would start to sell down its ETF positions on June 7, 2021. The latest list of the Fed’s ETF positions shows that not much has changed over the past six months.
For now, I am not going to revisit my commentary from last year on how the Secondary Market Corporate Credit Facility (SMCCF) could have been a tremendous opportunity to use smaller fixed income ETFs in order to achieve the Fed’s goal of stabilizing the bond market. Instead, I wanted to look back at what the program meant for the 16 ETFs that made the cut, and what we might see in the future.
Final ETF Assets
The current market value of the 16 ETFs the Fed holds is worth around $8.6 billion—down from $8.8 billion in January 2021. ETFs from five different ETF issuers were bought within the program; however, the three largest ETF issuers accounted for 14 of the 16 ETFs and 99% of the assets.
I am not going to go through each individual trade; however, if I simply look at the weighted average total return of those 16 ETFs over the past year, the Fed made around 4.5% on its investment.1
When the program was first announced, there was speculation on which ETFs would be purchased. Speculation became reality for 16 ETFs, and the inflows on the back of that selection have been staggering: approximately $76 billion of inflows since the program was announced through June 2, 2021,2 of which the Fed only purchased $8.6 billion. In contrast, the next 16 funds by assets under management (AUM) that we believe were eligible for inclusion only saw a combined $8 billion of inflows.
I can already hear your next question: “But Dave, doesn’t that make sense? Wouldn’t you expect more inflows for the larger ETFs?” The answer goes back to my initial reservations of choosing ETFs solely based on size, which is that it becomes a self-fulfilling prophecy. The market was exactly right in assuming that the Fed would pick the biggest funds, and that led to substantial inflows into those funds which are now even bigger—which makes them even more attractive to the next wave of investors. So on and so on.
Despite the Fed’s moves causing significant growth in the largest passive fixed income ETFs, active fixed income ETFs continue to gain more and more traction. We have discussed the possible tailwinds on the back of last year’s ETF rule—not only are there no operational differences between index and active funds, but now active fixed income can leverage the same custom basket capabilities that were previously only available to index funds.
The traction? Active fixed income ETFs are now up to $117 billion in total AUM, which represents about 10% of total fixed income ETFs assets in the United States.3 However, from a flow perspective, the $17 billion of active fixed income inflows in 2021 represents almost 20% of total fixed income flows year to date. We think the trend lines here are encouraging!
Of course, I hope that we never have another global event that would require the Fed to step in and support the bond markets via ETF purchases. But if that day does come, and if the Fed looks deeper than size alone, active fixed income ETFs should be there to answer the call!
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ETFs trade like stocks, fluctuate in market value and may trade above or below the ETF’s net asset value. Brokerage commissions and ETF expenses will reduce returns. ETF shares may be bought or sold throughout the day at their market price on the exchange on which they are listed. However, there can be no guarantee that an active trading market for ETF shares will be developed or maintained or that their listing will continue or remain unchanged. While the shares of ETFs are tradable on secondary markets, they may not readily trade in all market conditions and may trade at significant discounts in periods of market stress.
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1. Sources: Bloomberg, US Federal Reserve, June 1, 2020 – June 1, 2021. Past performance is not an indicator or guarantee of future results. See www.franklintempletondatasources.com for additional data provider information.
2. Source: Bloomberg. Total inflows from March 23, 2020 through June 2, 2021 in the 16 funds purchased by the Fed.
3. Source: Bloomberg, through June 3, 2021.