Some investors argue that actively managed funds are better capable of navigating through the fixed-income market. However, passive index-based bond exchange traded funds may do just as well, if not better, as active strategies.
“In the first eight months of 2015, investors added $37 billion into fixed income ETFs compared to the $85 billion for equity ETFs,” according to Todd Rosenbluth, S&P Capital IQ Director of ETF & Mutual Fund Research. “Though there are still a smaller number of highly liquid ETF choices for investors to consider, we think the driver behind the fund flow difference is that many investors believe that active management works better than passive with bonds. Unfortunately the data does not fully support this adage.”
Yields on benchmark 10-year Treasury notes were as high as 2.47% in June but traded below 2.0% earlier this year, “creating a recipe for astute active managers to outperform,” Rosenbluth said – yields and bond prices have an inverse relationship, so a rising yield corresponds with falling prices.
Active managers, who had a finger on the market pulse, could have diminished their bond fund durations to diminish the risk of rising rates. Meanwhile, index-based ETFs with a set target strategy cannot shift duration exposure to limit interest rate risks.
However, according to S&P Dow Jones Index Versus Active (SPIVA) research, over the one-year period ended June 2015, nine in ten active fixed-income mutual funds underperformed the Barclays benchmark index.
Additionally, a paltry 1.2% of government long funds outperformed the Barclays Long Government index over the past one-year period, and only 15% outperformed the benchmark in a five-year period. [Active Fund Aches: Are Passive ETFs More Profitable?]
The underperformance in active fixed-income funds suggests that investors would have been better off in a passive index-based strategy, such as the SPDR Barclays Long Treasury (NYSEArca: TLO), which tracks the widely observed Barclays Long U.S. Treasury Index. TLO has a duration of 17.4 years and a 2.68% 30-day SEC yield. TLO has dipped 1.6% year-to-date and generated an annualized average 6.1% return over the past five years. The ETF also shows a cheap 0.10% expense ratio.
Investors who are interested in greater diversification may track a bond fund with a range of debt securities, including government exposure and corporate debt. However, among the broader diversified investment-grade debt active category, only 17% of the funds in the investment style outperformed the Barclays Long Government/Credit Index for the year ended June 2015 and only 8% outperformed over the past five-years.
On the other hand, ETF investors can take a look at the Vanguard Long-Term Bond ETF (NYSEArca: BLV), which tracks the Barclays U.S. Long Government/Credit Float Adjusted Index, to exposure to a range of investment-grade government and corporate debt securities. BLV has a 14.7 year duration and a 4.08% 30-day SEC yield. BLV is down 3.1% year-to-date but generated an average annualized return of 6.1% over the past five years. The ETF also comes with a cheap 0.10% expense ratio.
For more information on the fixed-income market, visit our bond ETFs category.
Max Chen contributed to this article.