Actively Managed Bond Funds: Short-Term Underperformance, Longer-Term Strength
Updated June 2014
It’s a widely held belief that index funds outperform actively managed funds over time, and that’s certainly been the case when it comes to stock funds. In the bond world, however, managers have added meaningful value in the past five years.
Every six months, Standard & Poor’s (S&P) releases its S&P Indices Versus Active Funds (SPIVA) U.S. Scorecard. In the five-year period ended December 31, 2013, active managers outperformed in nine of the 13 categories tracked by S&P.
Active managers showed the largest degree of outperformance in the Investment-Grade Short and California Municipal Debt categories, where 71% and 67.5% of managers beat their benchmarks, respectively. The Investment-Grade Intermediate Funds category was also an area of strength, with about 63% of managers outperforming in the five-year interval. Outside of these top three categories, the best results occurred among General Municipal Debt Funds, Mortgage-Backed Securities Funds, and Government Short Funds.
The worst categories in the five-year period were emerging markets and high yield, where only 8% and 36% of managers exceeded their bonuses respectively. This is somewhat counterintuitive, given that active management and individual security research have more latitude to add value here than in any other area of the bond market. Perhaps one reason for the massive shortfalls in these segments is expenses since management fees in both groups tend to be well higher than the bond market as a whole.
Active Managers’ One- and Three-Year Results Are Unimpressive
On the negative side, shorter-term results were less favorable. 2013 proved to be a difficult year for managers, with indices outperforming funds in 10 of 13 categories. With the exception of the Investment-Grade Long, Government Long, and Global Income categories, bond fund managers lagged their benchmarks.
However, the outperformance in the first two categories was very impressive, with 96.8% of managers outperforming in Investment-Grade Long and 89.9% in Government Long. Active managers have the ability to protect against rising rates by reducing their funds’ duration, or interest-rate sensitivity, and clearly that was the case in 2013.
The overall numbers were only slightly better in the three-year period, with active managers outperforming in four categories. In this period, the outperforming managers were concentrated in the Investment-Grade Short, Investment-Grade Intermediate, General Municipal Debt, and Global Income categories.
Global Income was the only group in which managers outperformed in all three time periods. A possible explanation is that the larger investment universe provided active managers with a wider range of options from which to pick individual securities.
What Does This Tell Us About Active Management?
The recent results help illustrate the importance of taking a long-term view with actively managed funds. Managers can suffer wide performance swings in any given year, meaning that it can take time for the benefit of active management to become apparent.
Take PIMCO Total Return Fund (PTTAX).
As of March 31, 2014, the fund had generated an average annual total return of 5.42%, well ahead of the 4.46% return for the Barclays Aggregate Bond Index. Among individual calendar years, however, the chances of outperformance were just 50-50: the fund beat the benchmark in five years, and lagged in five.
The takeaway: active management can indeed add value, but investors need to exercise patience. However, extended periods of underperformance indicate that it’s time to consider the alternatives. To learn more, see my article “When to Sell a Bond Fund.”