Talk About the Benefits of Actively Managed Bonds

Investors are turning to passive equity strategies, prompted by evidence that suggests that most active managers have failed to beat their benchmarks. They charge steeper fees too, which sets the bar higher for actively managed funds to outperform. The trend into passive fixed income has also accelerated recently, but while research indicates passive may make sense for stocks, it tells a different story for bonds.

Fee dispersion between active and passive is lower for bonds than for equities


While it is true that active bond managers charge a higher fee than their passive counterparts, the difference between fees, as measured by the median expense ratios for U.S. ETF and U.S. open-end mutual fund Morningstar categories, is lower for bonds than for equities. This means that actively managed bond strategies are typically closer in cost versus passive bond strategies than actively managed equity strategies are versus passive equity strategies over time.

And, for active bond managers, that fee, which is typically used to employ credit research teams and risk analytics professionals, has the potential to pay for itself via higher return potential over time.

Actively managed bonds have outperformed passive over the longer term


Unlike the median active equity manager, which has underperformed its passive counterpart over the last 10 years, the median active bond manager has outperformed its passive peer by about 50 basis points. While these gains may not seem substantial, they compound over time and, if sustained, represent meaningful total return potential. Another key thing to note here is that passive managers typically underperform the index, due to fees.

Actively managed bonds have outperformed their benchmarks across a range of categories


About 65% of active bond managers outperformed their benchmarks across a range of popular Morningstar categories. In contrast, only about 37% of active managers in popular equity categories have outperformed their benchmarks.

Lower expected returns make active alpha more important than ever


Forward-looking returns are closely correlated with today's yields, which are near all-time lows. By going passive today, your bond portfolio will return approximately today's yield (less than 3%) on the index, minus fees, annually. In contrast, an active manager may be able to outperform over time, after fees.

The compounding value of active bond management


In a low-return environment, excess returns will account for a larger portion of total return going forward. As the hypothetical chart to the right shows, an excess return of 50 basis points annually will deliver $7,544 in total return, after fees, over a 10-year period, demonstrating that even a small gain over the benchmark can dramatically improve investment returns over the long term. There are, of course, many differences between active and passive and both approaches offer potential benefits, costs and risks.

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Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. High yield, lower-rated securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Floating rate loans are not traded on an exchange and are subject to significant credit, valuation and liquidity risk. Investing in foreign-denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging marketsManagement risk is the risk that the investment techniques and risk analyses applied by the investment manager will not produce the desired results, and that certain policies or developments may affect the investment techniques available to investment manager in connection with managing the strategy. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision.

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