- Active fixed income managers have an abundance of tools they can use to outperform their respective benchmarks, and the majority do.
- Distinct characteristics of securities, indices, and investor objectives create alpha opportunities for active fixed income managers.
- Fee differential between active and passive fixed income funds is negligible while active funds deliver superior long-term performance.
Today, it seems every financial expert is extolling the virtues of low-fee, passive index funds. While index funds can be an attractive option for some investment needs, the view that every asset class should be indexed is misguided. Many asset classes have nuances, inefficiencies, and liquidity constraints that an experienced manager can exploit to generate consistent alpha over the long-term. We believe the following will highlight why fixed income, particularly investment grade credit, is especially well-suited for active management.
Investment grade corporate bonds have several liquidity and trading characteristics that make passive investing challenging.
- High fragmentation – The Bloomberg Barclays U.S. Credit Index has 862 individual tickers and over 6,000 unique securities.
- No central exchange – Many securities in the index do not trade regularly and there are no dedicated market makers.
- Higher transaction costs – Bid offer spreads in corporate bonds are sizeable.
Index Composition & Market Participants
Index composition rules with respect to rebalancing, credit ratings, and bond characteristics create opportunities for alpha. The varied objectives of market participants can also present pricing inefficiencies.
- Frequent rebalancing – The makeup of the index changes monthly as debt matures and new debt is issued. Changes in credit ratings also create a regular need to rebalance.
- Non-index opportunities – Many alpha opportunities exist in securities that are not eligible for index inclusion due to issue size, SEC registration, credit rating, floating-rate coupons, or bond structure. The primary market also provides opportunities for alpha prior to index inclusion.
- Market participants – Many fixed income investors are focused on yield and income rather than total return. This can create pricing inefficiencies that an active manager can exploit.
Passive investment strategies have changed the landscape, but they are not always the best option. Passive fixed income funds may be useful to get short-term exposure to the market, but long-run performance will likely trail the index after fees. For investors with a longer-term horizon, active management in fixed income can provide superior results.
|Active Investing1||Q1 2018||1 Year||3 Years||5 Years||10 Years|
|Fort Washington Active Corporate Net||-2.17%||2.85%||3.08%||3.26%||5.99%|
|Median IG Credit Manager||-2.14%||2.72%||2.47%||3.20%||5.80%|
|Bloomberg Barclays US Credit Index||-2.13%||2.59%||2.16%||2.83%||5.15%|
|Excess Return of Fort Washington Active Corporate||-0.4%||0.26%||0.92%||0.43%||0.43%|
|Excess Return of Median Manager||-0.01%||0.13%||0.31%||0.37%||0.65%|
|Passive Investing2||Q1 2018||1 Year||3 Years||5 Years||10 Years|
|Liquid IG Corporate Bond ETF - LQD||-2.97%||2.72%||2.06%||3.02%||5.52%|
|Markit iBoxx USD Liquid IG Index||-2.92%||2.88%||2.34%||3.23%||5.85%|
|Median Fee of Active Manager1||0.30%|
1 eVestment: Median performance and fee derived from the U.S. Corporate Fixed Income peer group which includes around 90 observations. Median fee is calculated off of the median first breakpoint of $50 million.
2 Morningstar. Performance stated net of fees.
Assertion of active fixed income winning over time is based on views and opinions of Fort Washington and historical performance provided herein.
|Active Corporate Fixed Income (Gross)||-2.08%||7.38%||8.15%||-0.24%
|Active Corporate Fixed Income (Net)||-2.18%||6.95%||7.71%||-0.63%||8.01%||-3.12%|
|Bloomberg Barclays US Credit Index||-2.13%||6.18%||5.63%||-0.77%||7.53%||-2.01%|
|Active Corporate Fixed Income 3-Year Annual Standard Deviation1||-||4.13%||4.46%||4.32%||4.33%||4.60%|
|Barclays US Credit Index 3-Year Annual Standard Deviation1||-||3.72%||4.40%||4.06%||3.94%||4.23%|
|Number of Accounts||<5||<5||<5||<5||<5||<5|
|Composite Assets ($ millions)||$188.1||$192.0||$126.6||$80.8||$81.1||$78.5|
|Composite % of Firm Assets||0.36%||0.36%||0.28%||0.19%||0.18%||0.18%|
|Active Corporate Fixed Income (Gross)||9.92%
|Active Corporate Fixed Income (Net)||9.46%||9.14%||9.39%||19.80%||-2.37%|
|Bloomberg Barclays US Credit Index||9.39%||8.35%||8.47%||16.04%||-3.08%|
|Active Corporate Fixed Income 3-Year Annual Standard Deviation1||3.78%||4.57%||-||-||-|
|Barclays US Credit Index 3-Year Annual Standard Deviation1||3.64%||4.66%||-||-||-|
|Number of Accounts||<5||<5||<5||<5||<5|
|Composite Assets ($ millions)||$54.9||$66.3||$60.5||$77.5||$63.2|
|Composite % of Firm Assets||0.13%||0.18%||0.17%||0.26%||0.25%|