Active vs Passive – The Pros and Cons in Fixed Income
Bond investors can choose from a range of investment strategies to achieve their financial goals, including both active and passive fixed income approaches. Each strategy comes with distinct characteristics, benefits, and challenges.
Passive investment strategies
The two main passive strategies available to investors are buy-and-hold and index tracking approaches.
- Buy-and-hold strategy
- Index tracker strategy
This approach involves purchasing fixed income investments and holding them until maturity. Under this approach, the investor does not adjust their bond portfolio in response to market movements or short-term opportunities. This strategy may appeal to investors seeking the traditional benefits of bonds, such as capital preservation, predictable income, and diversification.
One of the main challenges associated with this strategy is reinvestment risk. When the bond matures, investors may need to reinvest the proceeds at lower yields if interest rates have fallen.
Index-tracking strategies aim to replicate the performance of a specific bond index. Bond indices, just like equity indices, are transparent and updated regularly. Passive exchange-traded funds (ETFs) and index-tracking bond funds seek to mirror the index’s returns by holding the same or similar securities as the index. Portfolio adjustments typically only occur when the index changes, rather than in response to market views.
A limitation of this approach is that passive investors typically cannot react quickly to sudden market shifts, which may lead to missed opportunities during volatile periods.
Active investment strategies
Active fixed income strategies aim to outperform bond indices by taking a more hands-on approach, trading individual bonds to capture opportunities created by changing market conditions. For active management to be successful over the long term, investors must analyse factors such as economic trends, interest rate movements, and credit conditions to identify opportunities.
One widely used active approach is total return investing, which combines income from coupon payments with potential price appreciation. Under this approach, portfolio managers look for bonds they believe are undervalued, hold them with the expectation that prices will rise, and then sell them before maturity to capture profits.
Active strategies give managers the flexibility to manage risks proactively, exploit market inefficiencies, and adjust portfolio duration, credit quality, or sector exposure as conditions evolve. However, these strategies typically involve higher fees and carry the risk of underperformance if market calls or economic forecasts prove incorrect.
What historical data shows
There is some debate about whether active investing can consistently deliver outperformance. However, studies of long-term returns suggest that active bond funds and ETFs have, on average, largely outperformed their passive counterparts after fees more frequently than active equity strategies have. Our analysis, covering two decades of historical returns for the U.S. equity and fixed income markets, shows that active bond funds in general have outperformed comparable passive strategies in 64% of the rolling 10-year periods examined. This compares favourably with a 43% success rate for active equity funds relative to their passive peers .
Returns for U.S. median active and passive managers over rolling 10-year periods
Source: PIMCO and Morningstar as of 30 September 2025. Past performance is not a guarantee or a reliable indicator of future results.
Active outperformance compares the performance of actively managed funds (net of fee) versus the median passive peer (net of fees) over 10-year periods. The average magnitude of outperformance over the 10-year periods is annualized.
“Active Bond Funds” represents actively managed mutual funds and ETFs in the Morningstar U.S. Taxable Bond and Municipal Bond Categories. “Active Equity Funds” represents actively managed mutual funds and ETFs in the Morningstar U.S. category groups of U.S. Equity, International Equity, Sector Equity, and Nontraditional Equity. Performance does not take into account the maximum initial sales charge and would be lower if it did. The net returns of Active Bond Funds and Active Equity Funds were compared against the median net returns of passive peers in each 10-year rolling period between 30 September 2005 and 30 September 2025 when both the funds being analyzed and the passive peers were present. Passive peers are mutual funds and ETFs classified as an “index fund” or an “enhanced index fund” in the same Morningstar category as the funds being analyzed. Oldest share class net returns are used for analysis. Results would vary if a different share class was selected. Different fund types (e.g. ETFs, open-end investment companies) and fund share classes are subject to different fees and expenses, which may affect performance, have different investment objectives, may have different minimum investment requirements, and may be entitled to different services.
This analysis spans two decades – a period that includes the global financial crisis, a pandemic, the 10-year Treasury yield falling to its all-time low, a sharp rise in inflation, and a generational reset higher in bond yields. It covers both bull and bear markets and a range of economic and market environments. Across this diverse set of conditions, active fixed income management, on average, outperformed passive approaches.
Active management does come with higher fees – typically about 35 basis points (bps) more than passive strategies across the five largest Morningstar fixed income categories by assets under management, as of 30 September 2025. However, when active managers are generating excess returns that exceed this additional cost, the value proposition becomes clear: Net-of-fees, active fixed income can deliver stronger long-term returns.
Which approach is right for you?
Passive strategies may suit investors who prioritise cost efficiency and prefer minimal involvement over the lifespan of their investment.
Active strategies may appeal to investors seeking greater flexibility and the potential for higher returns, particularly during periods of market volatility or uncertainty.
Ultimately, the right choice depends on an investor’s risk appetite, investment horizon, and overall portfolio objectives.
