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Bonding with Innovation: First Trust's Active ETFs Targeting Opportunistic Credit

The number of active ETFs on the market continues to surge, with a variety of issuers now taking the plunge into managing these vehicles. Among the launches, several trends have begun to take shape. Fixed income and the various opportunities, sub-asset classes, and strategies within the world of bonds are now driving new launches.

This includes two new funds from First Trust.

For investors, this underscores the fact active management can work wonders for fixed income assets, adding more returns and yield to a portfolio. Given the expansion into active ETFs, there’s no reason not to use them in your portfolio.

First Trust’s New Funds

Truth be told, First Trust has long been a ‘weird bird’ in the world of ETFs. The firm was one of the first pioneers to offer smart-beta and fundamental indexed ETFs in the early days of the investment vehicle. Moreover, it’s historically been one of the more expensive issuers in terms of expense ratios. As many firms looked to lower costs, First Trust has kept things a tad bit higher. It was also one of the first issuers to embrace active management with regard to ETFs. The manager launched its first active ETF back in 2010.

But that has not hurt its results, both in terms of performance and prowess in the ETF sector. The firm has managed to launch over 230 different ETFs with around $138 billion in ETF assets. That includes several multi-billion dollar funds.

Its latest ETF launches build on that legacy of active management and unique asset classes.

At the beginning of March, the firm launched the First Trust Commercial Mortgage Opportunities ETF (CAAA) and the First Trust Structured Credit Income Opportunities ETF (SCIO). Both will feature active management in their respective strategies. In keeping with First Trust ‘tradition’, expenses for the funds will be above industry averages, at 0.55% and 0.95%, respectively. 1

CAAA seeks to maximize long-term total return by buying commercial mortgage-backed securities (CMBS). CMBS are bonds collateralized by mortgages on commercial and multi-family properties. They can be fixed or floating rate. Under its mandate, CAAA will invest at least 90% of assets in CMBS with a AAA credit rating at the time of purchase and cannot invest in any security rated below A-.

SCIO seeks to maximize income by investing in various so-called structured credit assets. Structured credit is essentially pools of loans packaged into a bond. This can include credit card receivables, fleet financing, commercial- and residential mortgage-backed securities, small business loans, auto debt, etc. The fund can invest in any variety of these assets within its goal of maximizing income. SCIO can also invest in other funds that hold structured credit investments.

An Opportunity in Opportunistic Credit

Both funds follow a huge trend in the world of fixed income investing: private credit. Or in this case, and being more specific, opportunistic credit.

As the world has become more complex, so have its borrowing needs. An added dose of Great Recession regulation hindering bank-financed activity hasn’t hurt either. To that end, a variety of private lenders, hedge funds, private equity groups, and even major endowments have gotten into the lending game. This has led to a surge of private credit offerings. BlackRock predicts that by 2027, the private credit market will grow to over $2.7 trillion. To put that in perspective, the size of the U.S. junk bond market is only about $1.94 trillion, while the municipal bond market is roughly $3.8 trillion.

Opportunistic credit seeks to tackle these non-traditional loans and assets to help boost returns or generate income. Thanks to various factors, such as the lack of liquidity, the potential for floating rate coupon payments, and a lack of credit research, opportunistic credit can deliver higher returns without potentially taking on too much more credit risk.

Historically, the sector has long been outside retail investors’ hands. You needed to be an accredited or a high-net-worth investor to tackle some of these non-traditional bond varieties or own a structured credit fund. But ETFs—such as First Trust’s new launches—have now placed these non-traditional bonds into our hands.

Active Management Makes the Difference

This is one place where active management makes a difference. Fixed income indexes—even those that cover major bond markets—tend to be flawed in their construction. For example, the classic investment-grade benchmark—the Bloomberg Aggregate Bond Index—leaves out many bond types and is overweight U.S. Treasuries. Active bond managers have long been able to exploit these inefficacies within their benchmarks to generate additional returns.

For private credit and opportunistic credit, the benchmarks are already scarce. That unearths its potential. It takes some real credit research to dig into a pool of auto loans or a portfolio of office building mortgages to see how steady cash flows are, if the securities are trading at a value, etc. This is where active management can drive returns.

With the launch of First Trust’s new funds targeting the opportunistic credit sector, investors can now access that potential with one-ticker access and a low price. Even at 0.95%, it’s still cheaper than the fees on a private credit fund with some hedge fund manager.

First Trust’s launch also underscores investors’ appetites for fixed income assets. With rates now high and many bond varieties now yielding closer to their historic norms, investors need real guidance within the sector. Active ETFs have continued to provide that guidance and all the additional yield/returns that come with it.

First Trust Active Bond ETFs

These funds were selected based on their exposure to active bond management and are sponsored by First Trust. They are sorted by YTD total return, which ranges from -5.8% to 3.1%. They have assets under management between $329M and $7.4B and expenses between 0.45% to 1.02%. They are currently yielding between 3.04% and 7.69%.

In the end, First Trust may just have another couple of hits on its hands. As one of the pioneers in active and alternative indexing ETFs, the firm has continued to offer what investors want and need for their portfolios. For investors, the world of private credit and opportunistic bonds lends itself to a portfolio position. These latest two ETFs offer that exposure in a simple package.

The Bottom Line

Active ETF launches have been swift, with several major themes now in place. First Trust’s latest two launches fit those trends. Fixed income and, more specifically, opportunistic credit are firmly on the menu. With the potential for active management to shine in this strategy, First Trust’s ETFs could prove to be big hits.

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Apr 16, 2024