With the resurgence of inflation over the past several years, it’s been a very difficult environment to produce meaningful returns in fixed income. Duration exposure and curve positioning have driven much of the price action in bonds since 2022. But as the growth backdrop inevitably slows from elevated levels, fundamental credit analysis is likely to play a larger role in differentiating returns. I would argue this is the type of environment where active fixed income managers demonstrate their value.
When investing in a passive equity strategy that replicates a market cap–weighted equity index, in theory you are getting increased exposure to companies the market is rewarding and decreased exposure to companies the market is punishing. But investing in a strategy that replicates a market cap–weighted fixed income index does not have this feature. What you get instead is outsized exposure to the companies that are issuing the most debt. As there is often an observed inverse relationship between creditworthiness and amount of debt-securities outstanding, I would argue this is an undesirable characteristic – and is what is referred to as the “bums problem” in fixed income indices. I think it’s fair to say that this creates an easier hurdle for active managers to outperform fixed income indices compared to equity indices.
Active outperformance stats
This idea is supported by the percentage of active fixed income managers who outperform their respective benchmarks. Over the trailing 10-year time frame, 65% of intermediate core bond managers, 76% of high yield bond managers, 93% of bank loan managers and 94% of multisector bond managers outperform their benchmarks. Given the way these indices are constructed, it’s much easier for an active manager to differentiate a bond portfolio to deliver excess return compared to the benchmark relative to the equity space.