Fixed Income Managers Make the Case for Active Management
December 18, 2018
Investors seeking evidence that active managers demonstrate skill, persistence, ability with respect to market timing, and ultimately an ability to outperform passive funds need to look no further than fixed income. According to Morningstar research 70% of fund managers who pick and choose intermediate-term bonds are beating their passive peers, as highlighted in a recent Wall Street Journal story by Asjylyn Loder (Nov. 1, 2018 – “Unlike Stock Pickers, Active Bond Managers Are Beating the Market.”)
Academic researchers have found that active bond fund managers add value. For instance, in a 2015 paper, Fabio Moneta finds that they “exhibit outperformance before costs and fees generating, on average, gross returns of 1% per annum over the benchmark portfolio,” while Roberto C. Gutierrez, William F. Maxwell and Danielle Xu, in a 2009 study, conclude that “bond funds display persistence in performance that is long-lived.”
But what will drive outperformance in this asset class going forward? Asjylyn Loder’s story draws attention to something active bond managers have been preparing for – “the first prolonged period of rising interest rates in a generation.” She notes that active money managers have been preparing the rising rate environment, but index-tracking funds continue to load up on bonds. As rates rise, those bonds will potentially lose value negatively impacting performance.
Daniel Kruger reinforced this in a piece for The Wall Street Journal (11/8/18), pointing to the growing weight of Treasuries in indexes. “Actively managed bond funds,” he wrote “have performed better than their index-tracking peers recently, a trend some analysts credit to their efforts to pare back Treasury holdings. Rising rates erode the value of outstanding bonds, because newly issued debt offers higher payouts. And Federal Reserve officials have penciled in additional increases into 2020.”
Patrick O’Connor, who manages Franklin Templeton’s $1.5 billion ETF platform weighed in on actively managed bonds in a Bloomberg News article. He stated that fixed income indexes are “broken, making active management necessary for successful bond ETFs.
His rationale, according to Bloomberg? “The weight of individual securities in fixed-income indexes is often determined by debt issued, meaning companies that issue more debt will have a higher weight in an index-based ETF.” O’Connor goes on to say, “that doesn’t necessarily mean they’re the best companies, but they would be the ones that a passive manager would have to overweight.”
Historically, active fixed income managers have demonstrated skill and persistence with respect to bonds. Recent performance and the rising interest rate environments suggest they will have an opportunity to continue to demonstrate the value of active management in the future as well. For more information related to this and other actively managed asset classes please visit the “Insights” section of the Active Managers Council website for a wealth of research and thought leadership on active management.