With investors searching for safety in bonds from tumbling equity values, some fixed-income managers argue that active products provide better tax savings than passive funds.
Stock prices have been falling substantially every day since President Donald Trump’s announcement of tariffs last week, but global government bonds are staging a rally. As a traditional haven from equity volatility that is likely to get even more attractive if the Fed cuts interest rates to kick-start economic growth, fixed-income assets such as municipal bonds also carry tax benefits. But more asset managers are making the case that actively managed exchange-traded funds can tap into higher after-tax yields than passive products.
For example, the Tax-Aware Short Duration ETF, launched last year by BondBloxx and sub-advisor Income Research + Management, topped the Bloomberg Municipal 1-3 Year Index by 1.03% between its March 2024 inception date and the end of February. That product uses the ticker symbol “TAXX” — not to be confused with another recently opened ETF that uses the “TAX” ticker. The TAXX fund and other new and pending ETFs in the BondBloxx and IR+M collaboration reflect how increasingly sophisticated financial advisors and their clients are seeking products that can offer a combination of at least the required 50% municipal bond concentration required to access the tax-free income with the flexibility for active managers to target other types of fixed-income assets, said Tony Kelly, co-founder of BondBloxx.
“A year like this year, and a year like 2022, is a reminder that there’s value in diversification,” he said in an interview. “It’s a great hedge for volatility, but now with additional income in the portfolio, maybe it makes a little bit more sense for investors and advisors to allocate to fixed income.”
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Bad times for stocks are boon to bonds
With inflation and recession fears rising this year due to uncertainties surrounding the impact of President Trump’s tariffs and other moves so far by his second administration, investment experts have pointed to the importance of sticking to a long-term plan that isn’t based on any single day, week or even month on Wall Street. As advisors know, investor biases — like so-called herding, recency, loss aversion, availability and confirmation — can bring steeper losses than a mistaken strategy or even a sustained recession.
In that context, assets like gold or bonds could prove beneficial to the mix of holdings in clients’ portfolios. In fact, bonds have performed even better during recessions than gold, Amy Arnott, a portfolio strategist with research, technology and asset management firm Morningstar, wrote in an analysis last month of the best investments for those periods.
“Bonds have been the best place to be in most previous recessions,” Arnott wrote. “Investors often seek shelter in lower-risk assets during periods of economic distress, which helps support bond prices. In addition, the Federal Reserve often cuts interest rates in an attempt to stimulate economic growth, also resulting in higher bond prices. Because of their higher level of sensitivity to interest rates, long-term bonds have historically fared best during recessions, although intermediate-term bonds and cash have also been pretty resilient. Gold has also been a winning asset class during recessionary periods, with positive returns during the eight most recent recessions since 1993. But the yellow metal had a relatively anemic showing during recessions in the early 1980s and early 1990s; returns were negative after inflation.”
For retirees in particular, Treasury inflation-protected securities ladders, TIPS funds or Series I savings bonds could address concerns about the impact of rising prices from the tariffs, according to an analysis last week by Christine Benz, Morningstar’s director of personal finance and retirement planning.
“For retirees, checking inflation protection is particularly important for a few reasons,” Benz wrote. “First, more of their portfolios are apt to be staked in cash and bonds with income but little to no growth potential; higher prices eat away at the interest they pay out. Second, while Social Security helps make retirees whole with respect to higher prices, the portion of their ‘paychecks’ they’re withdrawing from their portfolios isn’t inherently inflation-adjusted. That’s why it’s important to build in a bulwark of inflation-protected assets into the safe portion of their portfolios, either a full-on Treasury Inflation-Protected Securities ladder or a complement of TIPS mutual funds/exchange-traded funds and I-bonds.”
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Higher TAXX, lower taxes
Within the fixed-income universe, though, some clients “tend to, at times, pay too much for the characteristics that you find in a municipal bond, because there’s so much demand to avoid taxes,” according to Kelly. The TAXX fund charges an expense ratio of 0.35%, and it has so far drawn net assets of $155.3 million, according to the product’s overview page. Currently, its holdings consist of 65% municipal debt, 19% of other securitized liabilities, 16% credit instruments and the rest in cash and equivalents.
“It’s your advisor market that traditionally has been investing in municipal bonds for their clients. Those are clients that are tax-sensitive, that think about returns already on an after-tax basis,” Kelly said. “What our tax-aware suite does is it challenges the idea that the way to maximize your after-tax return is by only investing in municipal bonds.”
Last month, BondBloxx and IR+M rolled out similar products to TAXX aimed at intermediate-duration bonds and another one for Massachusetts residents specifically. The firms have filed with the Securities and Exchange Commission for approval to launch two others focused on California and New York residents, Kelly noted. Bonds issued by governments in high-tax states bear income that is exempt from local, state and federal taxes.
Since he began his career in the ETF business around the year 2000, Kelly has watched a shift among investors he said once were not as concerned about fees and taxes. But ETFs have picked up their momentum at “every bump in the road market-wise” in the past 25 years, according to Kelly. The companies’ active bond products could take a previously manual process off advisors’ plates in garnering the highest possible after-tax yield.
“ETFs have gotten more than their fair share of money in motion each time the investors have reevaluated what they were doing,” he said. “This creates a bit of efficiency for those advisors. They don’t have to do that break-even analysis for their clients.”
