Active management in the fixed income space changes this script. Because they don’t have to track what the index says, managers can focus on a variety of other factors when making their portfolio selections.
For one thing, credit analysis can help unearth problems with a firm’s potential to repay their debts. Looking at various macro- and micro-economic factors can determine rates of cash flows, sales predictions, business trends and other forces that contribute to a company’s ability to cover their debts. This can also be done to overweight or underweight certain sectors of the market as we enter different portions of the business cycle.
This credit analysis can be taken a step further to help bond managers unearth potential values in the bond space. Extra yield can be had in these potential bargains without adding to the risk profile of the fund, which is similar to how value investing works with stocks.
Active bond managers can also manage duration and interest rate risk by tailoring their portfolios to the current and future predicted market environment, mitigating downturns when monetary policy shifts. Moreover, investors can go anywhere to choose the best bonds and fixed income investments from across the world to craft their portfolios.
All of this seems to work. A recent study by Morningstar showed that through 2018, actively managed fixed income mutual funds generated higher returns compared to passive funds during each of the one-, three-, five- and 10-year periods – and they did so in a big way. According to the study, the annualized returns for one year were 1.05% for actively managed bond funds versus negative 0.17% for passive bond funds. Looking out further, the three-year period was 2.98% (active) versus 2.82% (passive), 2.99% versus 2.49% for five years and 4.64% versus 3.71% for the ten-year period.
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