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Active bond funds are outperforming their passive counterparts

By Jamil Baz, PIMCO From Business Insider

Ask an investor if most active bond funds outperform their passive counterparts and the response is likely to be “no.”

After all, if one investor beats the market, another must lag it. Active strategies incur higher fees, so the majority should underperform their lower-fee passive counterparts. Recent media coverage on the rotation from active to passive funds – although focused chiefly on the equity market – may only reinforce this perception.

Our research suggests otherwise – at least for bonds, if not for stocks.

As the chart below shows, the majority of active bond funds and ETFs beat their median passive peers after fees over the past 1, 3, 5, 7 and 10 years, with 63% outperforming over the past 5 years. In contrast, the majority of active equity strategies failed to beat their median passive counterparts during the period. Only 43% outperformed over the past 5 years; in every other period, the percentage is lower still.

 

Bonds are different

We believe the reason why active bond strategies have been more successful than active equity approaches for this period lies in the bond market’s unique structure. Consider:

  • Noneconomic investors make up roughly 47% of the $102 trillion global bond market.Central banks, insurance companies and other noneconomic investors typically have objectives other than generating alpha. Central banks, for instance, may buy bonds to weaken their currency or boost inflation and asset prices. Commercial banks and insurance companies may care more about book yield or credit ratings than total return. The result: noneconomic investors leave alpha potential on the table for active bond managers.
  • The composition of bond indexes changes frequently. When fixed income securities join or leave an index, their prices tend to rise or fall as passive investors rush to buy or sell. Active investors seek to anticipate and profit from these changes.
  • Bonds, unlike stocks, mature after a number of years, leading to more turnover in the bond market. New securities make up about 20% of bond market capitalization annually, compared with about 1% in equity markets. Importantly, they typically are offered at concessional pricing to drive demand. Yet these discounts are generally not available to passive managers, who tend to buy new securities when they join an index, often a couple of weeks after they’ve been issued.
  • Structural tilts can be an important source of durable added value. Active managers, for instance, can target factors such as duration and exposures to high yield credit, mortgages, high yielding currencies and other sources of potential alpha.

In short, informational efficiencies make beating equity markets difficult. But we believe that’s not the case with fixed income, where noneconomic and passive investors pursue agendas that are not exclusively about total return.

Put simply, bonds are different.

Read the original article on PIMCO. Copyright 2017. Follow PIMCO on Twitter.

IMAGE: REUTERS/Lucas Jackson

For more on this story go to; http://www.businessinsider.com/active-bond-funds-are-outperforming-their-passive-counterparts-2017-4?utm_source=feedburner&amp%3Butm_medium=referral&utm_medium=feed&utm_campaign=Feed%3A+businessinsider+%28Business+Insider%29

 

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