Article Active Fixed Income ETFs: Bond expertise meets ETF efficiency

Active ETFs are rapidly entering into the mainstream of the European market. They’re no longer considered just niche funds but increasingly being used in diversified portfolios for allocation to key market segments. Assets under management rose to US$127.3 billion from US$23.1 billion in just three years to the end of June 2026¹. That works out to an annualised growth rate nearly 2 ½ times that of the broader ETF market¹. Yet, with still just 3.4% of the ETF market’s overall AUM¹, we believe active ETFs have more potential, including fundamental approaches that could be the next stage of investor demand.

There are now 420 active ETFs listed in Europe, compared to just 71 three years ago¹. New funds have come to the market both from existing ETF providers and from “pure play” active managers that are entirely new to ETFs. The larger, more established ETF providers may sometimes leverage proven active strategies from other parts of their business, and then use the expertise of their ETF specialists in product development, portfolio implementation, and trade execution to deliver it efficiently in the ETF format.

What is an active ETF?

When most investors hear the term active, they tend to think about the traditional bottom-up, stock-picking approach where a named manager uses their expertise and resources with the aim of outperforming the market. Their portfolios will often deviate significantly from a benchmark to achieve their objective.

While that is one type of active approach, active strategies can be defined more broadly as anything that isn’t passive. That’s particularly relevant considering the ETF wrapper is known — and used — mostly for passive exposure to both market-cap (beta) and “smart beta” indices. Active is everything outside of that.

Passive ETF investors first used “passive like” active ETFs

Most of the demand for active ETFs has been from experienced passive ETF investors. They initially focused on ETFs that take an underlying alpha strategy and apply tight constraints to limit deviation from a benchmark. “Core plus” and “enhanced beta” equity strategies are good examples, and they will often use teams of quantitative researchers as opposed to a single named manager.

Investors can evaluate and approve these products in much the same way they consider passive “smart beta” strategies — the active element of the strategy is limited and easier to reconcile with the familiar (passive) ETF operating model.

Then came active management used for reasons other than alpha

The next area of expansion for active ETFs were strategies where the active input was not primarily focused on alpha generation. This includes derivative-based strategies, such as those using options to generate additional income on an underlying equity index portfolio. The portfolio manager’s focus is not on timing the market or security selection, but on managing the complexities of a large options portfolio to deliver a high and stable level of income while at the same time retaining as much of the underlying index exposure as possible.

Another example are strategies that provide exposure to complex assets, which is best illustrated by the recent emergence of actively managed CLO UCITS ETFs. Each CLO is itself an actively managed portfolio of underlying loans, and the active manager adds the greatest value is two places: (a) the analysis of the CLO manager themselves, their track records, and how they have managed their portfolios historically (especially during periods of stress), and (b) in managing the complex trading dynamics of CLOs to ensure liquidity for investors. The expertise has more to do with trading and risk management than with the pursuit of alpha.

While these are clearly very different strategies from the enhanced core beta strategies, they share many of the same structural and risk characteristics, and their familiarity from a passive context facilitates their adoption by traditional passive ETF investors.

Next stage: Adoption of fundamental active ETFs?

As we have highlighted, passive ETF investors have been the main users of active ETFs and, for the most part, have focused on strategies sharing some characteristics with a passive approach. Interestingly, the next stage of active ETF growth could be from the type of strategy that many investors associate with active management, but that has only very recently started to gain traction: a fundamental active approach.

From a supply perspective, fundamental active strategies can pose material challenges to an ETF wrapper. And not every active strategy is suitable. For example, those that rely on less liquid securities to help deliver alpha are not ideally suited to a structure built for daily liquidity, transparency, and execution efficiency.

A fundamental active fund is built on the expectation that most investors will remain in the fund long term. The overall composition of the portfolio may change slightly with in/outflows as more liquid investments are bought/sold immediately while less liquid investments are executed more gradually. Smaller outflows are often dealt with by the fund’s cash holdings.

Contrast that to a passive ETF, which needs a liquid portfolio to accommodate the requirements of investors who wish to trade in and out of the fund opportunistically. The portfolio is constructed to replicate the benchmark and, as such, does not change. Absent any index rebalance activity, the passive ETF manager’s primary focus day-to-day is on the efficient management of in/outflows from the fund, which can at times represent a significant portion of total fund assets. The associated costs are borne by the investors buying or selling, so that the fund’s other investors are not impacted.

The design of fundamental active ETFs

The stark contrast between the structure, function, and overall business models of traditional fundamental active mutual funds and passive ETFs illustrates the design challenges in the construction of a fundamental active ETF. They also raise questions pertaining to the appropriate use and price of such a tool.

A compromise needs to be made between the two sets of criteria. The key comes in recognising that the active strategy is being put inside an ETF — the ETF wrapper sits on the outside and defines the way in which the product interfaces with market. Therefore, the demands of the ETF will generally take precedence.

The solution: Two distinct skill sets

From a strategy perspective, the active ETF ideally would leverage the alpha insights of the manager but restrict their scope to a universe of sufficiently liquid assets to meet the demands of ETF investors. In some cases, this may be the entire strategy, and in others it may be only a subset of the core strategy.

In terms of managing operational flows, the key is to separate two distinct skill sets:

• The active management team concentrates on research, security selection, and portfolio construction.
• The ETF specialists concentrate on creations and redemptions, execution, and interaction with authorised participants and market makers.

This hybrid model resembles the division of labour created by a centralised dealing desk: Deciding what to own is different from executing transactions efficiently. For an active fixed income ETF, the active team can define the desired portfolio and the bonds it is willing to receive or deliver, while the ETF team manages daily flows using established infrastructure and market relationships.

Fixed income ETFs can also use negotiated custom baskets for primary-market activity. In a passive portfolio, optimisation generally seeks to preserve or improve benchmark tracking. In a fundamental active portfolio, the active managers can instead guide implementation through lists of bonds they are prepared to add, retain, or sell. Used well, flows become an implementation tool rather than a distraction from alpha generation.

Finally, when it comes to price, this is largely already solved by the structure. If an active strategy is already designed to be liquid, few modifications are required to put it inside the ETF wrapper, which removes the justification for differentiated pricing. However, if the active ETF is a more liquid variant of an active mutual fund strategy, it is likely to capture only a subset of the true alpha potential of the manager. The trade-off for the reduced alpha opportunity is that the ETF comes at a lower price point.

How can fundamental active fixed income ETFs be used in a portfolio?

First, they can provide investors who use only ETFs with access to fundamental research-based credit expertise without abandoning the operational model they already use. This may be relevant for investors seeking an active alternative for their core allocation in certain areas, such as for active exposure to EUR investment grade corporate bonds.

Second, an active bond ETF can complement an existing active mutual fund. An investor might retain a strategic allocation to the broader mutual fund strategy while using the ETF as a more liquid sleeve for cash flow management or tactical adjustments. Where the two vehicles follow substantially the same investment philosophy, this can reduce the style mismatch that arises when the liquidity sleeve is held in a passive exposure.

Finally, an active ETF may also help an active mutual fund manage residual cash more efficiently, if the vehicles are aligned. Rather than maintaining uninvested cash or trading many underlying bonds for day-to-day liquidity needs, the manager may be able to use the ETF as a liquid expression of the same strategy.

Why Invesco for active fixed income ETFs

Invesco has a long history in managing fundamental, research-driven active funds, with substantial global resources and dedicated research and investment teams providing specialist fixed income expertise. We have provided investors with solutions via our highly efficient ETF platform for nearly a quarter-century, currently managing $1.2 trillion of ETF assets globally², and have been offering active ETFs for more than 20 years.

Our growing range of active ETFs includes market-leading exposures to niche fixed income segments such as CLOs, and to broader asset classes such as EUR investment grade corporate bonds.

We operate a hybrid model that enables our specialist teams to concentrate on their areas of expertise without distraction. Active fixed income managers can focus on constructing their portfolios, with the implementation and efficient handling of flows delegated to ETF specialists. Our capital markets team works with authorised participants and market makers to ensure investors can trade our ETFs cost efficiently.

Conclusion: ETFs that deliver a higher standard for active judgement 

Active fixed income ETFs are not inherently core allocations, nor is every fundamental strategy suitable for an ETF. The strongest candidates are those in which research insights can be expressed in sufficiently liquid securities and where the manager can work with an experienced ETF team without compromising the investment objective.

When those conditions are met, the wrapper need not weaken active management. It can impose useful discipline: a clearly defined liquid universe, explicit portfolio construction, transparent implementation and a robust process for daily flows. For professional investors, that creates a practical middle ground — fundamental bond expertise delivered through an efficient, familiar portfolio tool.

Learn more about Invesco’s Fixed Income ETFs.