While passive strategies best perform during liquid, efficiently priced markets, those conditions aren’t always met — and they’re certainly not being met now. That’s where active management can provide a leg up for investors.
Passive strategies often lack the flexibility to adapt to changing market environments. Meanwhile, active bond ETFs can offer the potential to outperform fixed income benchmarks and indexes.
Over at Morningstar, Lan Anh Tran, an associate manager research analyst for Morningstar Research Services argues that there are two areas of the fixed income market – high-yield bonds and bank loans – where a good active manager may be a better option than an index fund.
According to Tran, high-yield bonds carry an increased chance of default. The risks are not only high but sometimes not readily apparent. Since high-yield bonds don’t trade on exchanges, this decentralized trading can limit the information available to investors. This leads to a high potential for mispricing in this market, which can be a serious impediment to a passive investor.
An active manager can conduct “fundamental research to evaluate a company’s default risk rather than blindly reaching for yield, while an index portfolio is stuck paying the market price,” wrote Tran. “A good active manager can also identify pockets of potential among the lowest rungs of the credit-rating ladder, where the dispersion of returns is wider.”
Bank loans are another sector where active management can help. Like high-yield bonds, bank loans carry a high amount of risk since most issuers are rated below investment grade. While considered safer than high-yield bonds, bank loans also have more quirks that make them ill-suited for index funds. Their trades also take longer to settle, which complicates the daily liquidity needs of ETFs.
So, with bank loans, an active manager has the discretion to consider investments on their merits and act opportunistically.
“[A]ctive managers have a leg up on passive funds in the high-yield bond and bank-loan markets, but this logic extends to any category where liquidity may be lacking and mispricing abundant,” wrote Tran. “Investors need to perform extensive due diligence to pick the right active managers, but the probability of success against the average passive fund is higher in these markets.”
As part of its lineup of active exchange traded funds, T. Rowe Price offers a suite of actively managed fixed income ETFs, including the T. Rowe Price QM U.S. Bond ETF (TAGG), the T. Rowe Price Total Return ETF (TOTR), and the T. Rowe Price Ultra Short-Term Bond ETF (TBUX).
T. Rowe Price has been in the investing business for over 80 years, conducting field research firsthand with companies, utilizing risk management, and employing a team of experienced portfolio managers carrying an average of 22 years of experience.
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