Passive funds lagged their benchmarks across all categories
Only some actively managed bond funds and ETFs outperform indices offering equivalent exposure, according to a Bloomberg study which challenges the commonly held belief that skilled portfolio managers can reliably capture higher returns in fixed income.
Inefficiencies in bond markets should provide plentiful opportunities for active managers to deliver alpha – above benchmark returns – but Bloomberg’s analysis concludes that index-based strategies could replicate much of their performance.
“Many active fixed income strategies could be replicated through passive funds tracking indices, potentially delivering similar outcomes at significantly lower cost. While some active fixed income managers do outperform passive strategies, they are relatively few, and the scale of their outperformance is often modest, far lower than commonly perceived,” wrote Yingjin Gan, Bloomberg’s head of index research, and Vikas Jain, a quantitative researcher, who co-authored the study entitled Behind the benchmark: Dissecting active bond fund performance.
The two analysts examined the performance of 1,454 US bond funds, net of fees, between January 1999 and December 2024 to find evidence of managers skill. Data from funds that were liquidated, delisted or acquired were included up to the date of their closure. Bond funds that launched after January 1999 were included with return data from the date of their debut. Approximately 75% (1,090) of the funds were actively managed.
Actively managed government bond funds and high yield funds generally struggled to consistently beat their benchmarks. However, actively managed investment grade bond funds along with “Aggregate” funds, the most diversified category, did achieve strong outperformance with average (median) annualised returns of 0.19% and 0.17% compared with their underlying benchmarks.
The higher returns reported by actively managed US aggregate bond funds were mostly explained by managers taking on more risk via positions in high yield and emerging market bonds, the researchers said. Fluctuations in market conditions also influenced the performance of actively managed funds as more beat their benchmarks in years when credit spreads tightened and high-yield segments rallied.
However, the authors do concede there are downfalls to comparing funds with unavoidable running costs against theoretical indices.
“A potential concern with using benchmark indices as the reference point is that fund returns incorporate transaction costs and fees, while index returns typically do not, which may disadvantage active funds in such comparisons,” they said.
Notably, passively managed US bond funds underperformed their underlying indices across all four categories by between 0.06% for the median fund in the government category and 0.46% for the median fund in the high yield sector, reflecting the higher transaction costs associated with that category.
The analysts also point out that the number of unique benchmarks (238) was high relative to the number of active bond funds, underscoring the complexity of benchmarking in fixed income markets. The Bloomberg US Aggregate bond index was the most widely used benchmark in the aggregate fund category and it was also used by around 10% of high yield active funds. In Europe, BlackRock’s $6bn iShares US aggregate Bond UCITS ETF (IUAA) and State Street Investment Management’s $179m SPDR Bloomberg US Aggregate Bond UCITS ETF (SYBU) both track the Bloomberg US Aggregate bond index.
To more accurately assess the performance of actively managed funds, the analysts then created new risk-adjusted “technical” benchmarks from a variety of combinations of the Bloomberg US aggregate index and the Bloomberg US high yield index. Both the number of actively managed funds delivering true alpha (skill) and the size of that alpha (excess returns) were “materially reduced” when measured against the technical benchmarks.
“The bar for demonstrating true skill is significantly higher when evaluated against an appropriate benchmark,” wrote Gan and Jain.
They also examined the performance of actively managed bonds funds during the five worst quarters for the US stock market. Between 70% and 90% of the actively managed bond funds underperformed their benchmarks during these periods of stock market declines. This suggested that actively managed bond funds could amplify the sensitivity of a diversified multi-asset portfolio to stock market stress instead of acting as a stabilising counterbalance.
“By persistently tilting towards higher spread assets, active funds may sacrifice the traditional defensive characteristics of fixed income. This can reduce their effectiveness during risk-off environments, calling into question whether the added yield is worth the increased drawdown risk in multi-asset portfolios,” cautioned Gan and Jain.
Bloomberg is the fourth largest index provider to the ETF industry and a specialist in fixed income indices tracked by passive funds and benchmarked against by active funds. Global assets worth just under $1.5trn were invested in 814 ETFs tracking Bloomberg indices at the end of December, according to the data provider ETFGI.
The firm’s findings add to an already lively debate between passive and active camps, raising further questions about how the performance of both management styles should assessed.
Originally published on ETF Stream.
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