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Research Spotlight | The Case for the Active Management of Bond Funds

Research Spotlight | The Case for the Active Management of Bond Funds

April 5, 2024

The Bottom Line: A new study finds that “active bond funds tend to add value,” leading the authors to conclude that “there are strong, rational reasons for investors to consider active bond funds.”

The Study: “Passive bond fund management is an oxymoron (or the case for the active management of bond funds) by Jaewon Choi, K. J. Martijn Cremers, and Timothy B. Riley. March 2024 working paper available on SSRN.

The Process: The study focuses on U.S. taxable bond funds in the ten-year period ending 2021. The authors compare the performance of the actively-managed funds to that of the passively-managed funds. They also examine how active and passive funds differ in investment approach and portfolio composition, as measured by active share and asset illiquidity. 

The Findings: With regard to performance, the study finds “no evidence that the average active bond fund underperforms a set of equivalent passive funds” and that there is even some evidence that active bond funds outperform.

Significantly, the funds with the highest active share “tend to substantially outperform, particularly if they have strong past performance.” These funds also tend to have lower maximum drawdowns and “exhibit less financial fragility.” These improved outcomes are attributable to both firm-level and bond-level selection skill.

Turning to the passively-managed funds, the authors argue that “calling them passive could be a misnomer,” given that they “trade intensely and are very different from their benchmarks.” They note that tracking a bond benchmark involves “unique challenges” given the large number and often limited liquidity of issues in most fixed income indexes.

The Implications: The paper confirms the conventional wisdom – namely, in fixed income, it’s hard to draw a line between active and passive management. In that environment, greater investment flexibility can lead to improved returns, which is supported by the study’s finding that funds with high active share outperform substantially. Overall, the study suggests that recent inflows into active bond funds are the result of rational decisions by investors.

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