Being Active with Fixed Income:
Active Bond Managers Are Beating the Market

November 2018 | Public Version

Over the past decade, there has been much written about and discussed in the financial media over the debate between active and passive investing. During that timeframe, many fixed income investors have jumped on the passive investing bandwagon due to their laser focus on management fees and the assumption that there aren’t many idiosyncratic risks to exploit compared to equities in order to generate alpha. However, the truth of the matter is that across the fixed income space, passive strategies have for the most part underperformed active strategies, while exposing investors to more risk in their portfolios. Actively managed fixed income funds can also include investment opportunities that are not available to passive funds.

One of the main problems with passive fixed income strategies is that they cannot effectively manage duration like actively managed strategies can. In today’s rising rate environment this is problematic because historical data shows as the Fed raised interest rates, higher duration bonds have experienced a greater risk of loss compared to shorter duration bonds. Since actively managed bond funds have the ability to shift toward short-term debt, this allows them to mitigate interest rate risk in an attempt to outperform index-tracking bond funds.

Unlike actively managed fixed income funds, passive funds cannot effectively manage duration risk making them more vulnerable in today’s environment.

The Problem with High Duration Bonds During Periods of Rising Rates

Historically, if interest rates change by 1%, a fixed income fund’s price is likely to experience an inverse change by approximately 1% for each year of duration.

Passive Fixed Income Fund Duration Has Steadily Increased Since 2007

Based on data from January 2007 to June 2018.

Source: Morningstar Direct/Wall Street Journal. Taxable bond mutual fund data from Morningstar and Bloomberg, via Investment Company Institute.


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