20-plus years ago, I graduated college and spent the next few years doing bond math to help pick the right bond for clients. To this day, I think of the world in “what’s the risk, how can it go wrong, and what do I get back” bond world terms. So, whenever I see interesting data about the fixed-income market, particularly the active vs. passive debate, I get excited. Now that high rates are making everyone look at bonds again, the question of “how best to do it” warrants attention.
Last week, Apollo Global Management published a short note on this very topic. They highlighted that public bond management is looking increasingly like a beta allocation rather than a place to pay for manager selection. Of course, we’ve held this view for quite a few years at LEO Wealth (I finally saw the light!), which is why we use ETFs instead of single bonds in our clients’ fixed-income allocations. Please allow me to repeat Apollo’s key takeaways and share the relevant charts:
- The performance gap between 90th- and 10th-percentile managers has narrowed from 1.9% in the 2000s, to 1.5% in the 2010s and just 1.1% since 2020. Dispersion still increases during market stress but falls back quickly afterward.
- At the same time, active bond managers have struggled to beat their benchmarks. S&P data shows 96%+ of active treasury fixed-income funds underperforming their benchmark over 10 years. The numbers are marginally better for investment-grade credit and high yield, with “only” 75% and 87% underperforming, respectively. In short, most active bond funds underperform.
These two observations lead to a simple question. If most managers underperform, and the difference between stronger and weaker ones is shrinking, how likely are investors to get excess returns net of fees? This question is the reason we tend not to use active bond funds in our portfolios. Not only do we not want to pay high expense ratios, we also don’t like the transaction costs involved. Bonds mostly trade over the counter, and even the largest bond fund managers must pay careful attention to their execution costs. And retail investors trading individual bonds? The average bid-ask spread is 1% or more, transferring a large portion of return from investor to market maker.
This doesn’t mean active fixed income has no role. Sometimes an individual bond ladder makes sense. We can do this through bonds or ETFs. But for core fixed income allocations, the bond ETF market is now robust enough to allow us to express granular interest rate, credit, and currency views without trading a single bond or using a bond fund. The expense ratios and transaction costs are lower, while diversification and returns are higher. For investors considering fixed-income allocations given higher yields ahead, a core bond ETF portfolio may be the best allocation tool available today.
Public Fixed Income: Performance of Top and Bottom Bond Managers Converging
Percentage of Active Fixed Income Funds Underperforming Their Benchmark
DISCLOSURES
The information provided is for educational purposes only. The views expressed here are those of the author and may not represent the views of Leo Wealth. Neither Leo Wealth nor the author makes any warranty or representation as to this information’s accuracy, completeness, or reliability. Please be advised that this content may contain errors, is subject to revision at all times, and should not be relied upon for any purpose. Under no circumstances shall Leo Wealth be liable to you or anyone else for damage stemming from the use or misuse of this information. Neither Leo Wealth nor the author offers legal or tax advice. Tax services provided are separate from the Securities or Advisory services offered through Leo Wealth Americas. Please consult the appropriate professional regarding your individual circumstance. Past performance is no guarantee of future results.
This material represents an assessment of the market and economic environment at a specific point in time. It is not intended to be a forecast of future events or a guarantee of future results.
Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks, including changes in credit quality, liquidity, prepayments, and other factors. REIT risks include changes in real estate values and property taxes, interest rates, cash flow of underlying real estate assets, supply and demand, and the management skill and creditworthiness of the issuer.
Active portfolio management, including market timing, can subject longer term investors to potentially higher fees and can have a negative effect on the long-term performance due to the transaction costs of the short-term trading. In addition, there may be potential tax consequences from these strategies. Active portfolio management and market timing may be unsuitable for some investors depending on their specific investment objectives and financial position. Active portfolio management does not guarantee a profit or protect against a loss in a declining market.
Neither Asset Allocation nor Diversification guarantee a profit or protect against a loss in a declining market. They are methods used to help manage investment risk.
Exchange Traded Funds (ETF’s) are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest. An investment in the Fund involves risk, including possible loss of principal.
