BrightTALK Speech Rieger Report®: Active or Passive Bond Funds: Hype v. Facts

Active or Passive Bond Funds: Hype v. Facts

On October 28th JR spoke at the webinar “BrightTalk: Active v. Passive Bond Funds: Hype & Facts” on the trends of active versus passive fixed income options. Below is the presentation from that webinar.

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Active or Passive Bond Funds: Hype v. Facts

In this world of many different choices for fixed income exposure the debate rages about whether passive management or active management is the best approach.  I view the various choices as “tools” in the investor tool box and sometimes one tool might be better than another.  Of course, this year, 2020, was supposed to be the year of actively managed bond funds to outperform, strut their stuff.  I’ll go into more detail on that.  We’ll discuss the current state of ETFs, the S&P Spiva Scorecard, Morningstar’s Active/Passive Barometer, S&P’s Persistence Scorecard, and then put the facts out there by comparing specific funds to each other.  I’ll conclude with a discussion about new trends and new ETFs.
  • 2020 the year of active management for fixed income?
  • Current state of ETFs
  • S&P Dow Jones Indices SPIVA® U.S. Scorecard (S&P Index v. Active)
  • Morningstar’s Active/Passive Barometer
  • S&P’s U.S. Persistence Scorecard Year-end 2019 (Performance persistence)
  • Compare actual 2020 YTD returns of active & passive of select bond ETFs
  • New trends/new ETFs

Investor Behavior

Before we go too much further, we do need to talk about investor behavior.  We all want to win. Nobody likes losses, there is the fear of missing out, no one likes to overpay for anything and investor inertia is hard to overcome.

  • Win – we all want to outperform the market
  • Losses – nobody likes losses
  • FOMO
  • Overpaying – CARFAX ads
  • Inertia – change can be hard

Current State of Fixed Income ETFs

In looking at the overall state of fixed income Exchange Traded Funds or ETFs we can see that the total assets in these funds has grown to well over $1trillion. This is substantial growth as these funds really only began about 15 years ago.  Most of the assets are in low-cost or low management fee products that represent the “beta” of the market they are tracking or passively managed to an index that tracks the market.

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Sources:  ETF Action. Data as 10/23/2020. Table is provided for illustrative purposes only.  Past performance is not a guarantee of future results.

S&P’s SPIVA U.S. Scorecard

“You are going to do what? “

Years ago, in 2009 or 2010, when I was still fairly new at S&P Indices the head of research called a meeting.

He introduced the SPIVA Scorecard: a semi-annual report that shows performance of active equity fund managers v. certain indices or benchmarks.  It shows how infrequently stock pickers out pace the marketplace.

He also said he was adding fixed income funds to the report.

My reaction was “you are going to do what?” and “not going to work!”  After all, active bond funds have the best fund managers, analysts, access to data, analytics, and access to bonds – they can beat an index!  Boy was I wrong.

Years later, I still study this data.  While at times, active managers do show some positive performance v. an index its not the majority of times and when it happens it seems to be very sporadic.

S&P’s SPIVA® U.S. Scorecard

Mid-Year 2020 Report

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I’m introducing the S&P SPIVA U.S. Scorecard with this slide.  It is released twice a year and can be found on www.spindices.com.  It shows the % of funds that are outperformed by benchmarks with the same investment objective.

Source:  S&P Dow Jones Indices LLC.  SPIVA® U.S. Scorecard Mid-Year 2020 published September 21, 2020. Table is provided for illustrative purposes only.  Past performance is not a guarantee of future results.

S&P’s SPIVA® U.S. Scorecard: Close Up

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Looking deeper at the data, for a rather simple bond exposure of U.S. Treasury bonds, actively managed U.S. Treasury bond funds did rather poorly v. U.S. treasury bond indices and consistently so over 1, 3, 5, 10 and 15 year periods of time.

Source:  S&P Dow Jones Indices LLC.  SPIVA® U.S. Scorecard Mid-Year 2020 published September 21, 2020. Table is provided for illustrative purposes only.  Past performance is not a guarantee of future results.

S&P’s SPIVA® U.S. Scorecard:

Investment-Grade Intermediate Funds

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Actively managed investment grade intermediate bond funds were the “shining light” in this data with about 50% outperforming an index. But as we will see, its the only asset class that has decent performance.

Source:  S&P Dow Jones Indices LLC.  SPIVA® U.S. Scorecard Mid-Year 2020 published September 21, 2020. Table is provided for illustrative purposes only.  Past performance is not a guarantee of future results.

S&P’s SPIVA® U.S. Scorecard:

High Yield Funds

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Actively managed high yield bond funds performed poorly v. the index.

Source:  S&P Dow Jones Indices LLC.  SPIVA® U.S. Scorecard Mid-Year 2020 published September 21, 2020. Table is provided for illustrative purposes only.  Past performance is not a guarantee of future results.

S&P’s SPIVA® U.S. Scorecard:

Emerging Markets Debts Funds

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Actively managed emerging market funds did even worse.

Source:  S&P Dow Jones Indices LLC.  SPIVA® U.S. Scorecard Mid-Year 2020 published September 21, 2020. Table is provided for illustrative purposes only.  Past performance is not a guarantee of future results.

S&P’s SPIVA® U.S. Scorecard:

General Municipal Debt Funds

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Investment grade municipal bond funds performance was not so hot v. an index.

Source:  S&P Dow Jones Indices LLC.  SPIVA® U.S. Scorecard Mid-Year 2020 published September 21, 2020. Table is provided for illustrative purposes only.  Past performance is not a guarantee of future results.

S&P’s SPIVA® U.S. Scorecard:

S&P’s SPIVA® U.S. Scorecard’s Mid-Year 2020 Report provides even more transparency, S&P also includes:

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To provide even more transparency S&P includes the average performance of each group of funds v. the index performance.  It provides the average performance calculated by equal-weight and by asset-weight.  In either case, the data shows underperformance v. an index.

Source:  S&P Dow Jones Indices LLC.  SPIVA® U.S. Scorecard Mid-Year 2020 published September 21, 2020. Table is provided for illustrative purposes only.  Past performance is not a guarantee of future results.

Why is Performance so Bad?

  • Indices don’t have trading costs or management fees
  • Indices assume all bonds in the index are available for sale/purchase at the price used in the index
  • Indices are rules based
  • Portfolio managers make interest rate, duration, sector and credit risk allocations or “bets” in an effort to outperform
  • But still…. I’d expect better performance statistics v. benchmarks

Morningstar’s Active/Passive Barometer

August 2020

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The other resource available to us is Morningstar’s Active/Passive Barometer which can be found on www.morningstar.com.  It evaluates active funds against a composite of actual passive funds.

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For corporate bond funds, actively managed bond funds only had a “success rate” of 30% year-to-date where “success” is defined as outperforming the passively managed peer group.

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High yield bond funds were modestly better with a 42% success rate.

S&P’s U.S. Persistence Scorecard

Year-end 2019

Does Past Performance Matter?

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S&P also publishes the S&P U.S. Persistence Scorecard.  Here I took a table from that report which illustrates the percentage of funds in the top quartile at the end of 2017 that were still in the top quartile at the end of 2018 and 2019.  Rather dismal performance persistence can be seen across the fixed income asset classes tracked.  In other words, picking the best portfolio managers that can outperform year after year can be difficult!

Source:  S&P Dow Jones Indices LLC.  S&P Persistence Scorecard published June 29, 2020. Table is provided for illustrative purposes only.  Past performance is not a guarantee of future results.

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Just picking on the investment-grade intermediate funds as an example, 50 of them were in the top quartile of performance at the end of 2017 and on 2 of them or 4% remained in the top quartile by the end of 2019.

Source:  S&P Dow Jones Indices LLC.  S&P Persistence Scorecard published June 29, 2020. Table is provided for illustrative purposes only.  Past performance is not a guarantee of future results.

Broad Bond ETFs YTD Performance

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I jammed a lot of data into these next slides.  I am comparing actual actively managed fund performance to actual passive fund performance. A peer to peer comparison if you will.  Some big names are here but as you can see actively managed broad bond ETF exposure is very inconsistent v. the passively managed funds which are run at much lower management fees.

Sources:  ETFAction.com Chart is provided for illustrative purposes only.  Past performance is not a guarantee of future results. Not all ETFs or asset classes represented here. FactSet classifications are used.  Data as 10/21/2020.

Investment Grade Municipal Bond ETFs

YTD Performance

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The same comparison is done for investment grade municipal bond ETFs.  Where actively managed fund performance varies significantly.  Note the lower cost of the passively managed municipal bond funds.

Sources: ETFAction.com Chart is provided for illustrative purposes only.  Past performance is not a guarantee of future results. Not all ETFs or asset classes represented here. FactSet classifications are used.  Data as 10/21/2020.

Intermediate Term Municipal Bond ETFs

YTD Performance

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The same holds true for intermediate municipal bond funds.

Sources: ETFAction.com Chart is provided for illustrative purposes only.  Past performance is not a guarantee of future results. Not all ETFs or asset classes represented here. FactSet classifications are used.  Data as 10/21/2020.

Mortgage Backed Bond ETFs 

YTD Performance

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Funds of Mortgage-Backed Securities or MBS is the only example where actively managed bond funds have demonstrated an “edge” v. their passively managed peers.

Sources: ETFAction.com Chart is provided for illustrative purposes only.  Past performance is not a guarantee of future results. Not all ETFs or asset classes represented here. FactSet classifications are used.  Data as 10/21/2020.

USD High Yield Bond ETFs

YTD Performance

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In the junk bond market, actively managed ETFs have seen a wide performance range year-to-date.  Some have indeed outperformed, but it appears we need to select our managers very carefully.

Sources: ETFAction.com Chart is provided for illustrative purposes only.  Past performance is not a guarantee of future results. Not all ETFs or asset classes represented here. FactSet classifications are used.  Data as 10/21/2020.

USD Senior Loan ETFs

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In the senior loan asset class, also known as bank loans or leveraged loans, performance is spotty.  I included this asset class to highlight the importance of “knowing your index” when investing in passive fixed income funds.  Make sure it meets your investment objective including risk profile.

Sources: ETFAction.com Chart is provided for illustrative purposes only.  Past performance is not a guarantee of future results. Not all ETFs or asset classes represented here. FactSet classifications are used.  Data as 10/21/2020.

Notable New Fixed Income ETF Launches

Switching the conversation over to new trends in the fixed income market we are seeing an increase in ESG related fixed income products become available.  At the largest conference for ETFs, Inside ETFs in January of this year it was predicted that this would be the year of ESG related investing and certainly the products that have come to market include ESG.   I’ve listed here a few new funds that have launched recently.  Some are “me too” products aiming to compete head-to-head with existing funds and others are new concepts.  Interesting to me is the iShares BB Rated Corporate Bond ETF (HYBB).  This new fund gives is a new tool in the toolbox to invest in only the double B category of junk bonds.  Why take on the risk of CCC or below bonds when you can grab incremental yield in the BB slice? Another example of new issuance is the Vanguard ESG U.S. Corporate Bond ETF (VCEB).  While competing v. the iShares product it offers a slightly lower cost and while providing ESG factors for investing in fixed income.

10/13/2020 Avantis Core Fixed Income (AVIG)

  • Management fee: 15bps
  • Active overlay to the Bloomberg Barclays U.S. Aggregate Bond Index

10/6/2020: iShares BB Rated Corporate Bond ETF (HYBB)

  • Management fee: 25bps
  • Passive

10/2/2020: Clearshares Piton Intermediate Fixed Income ETF (PIFI)

  • Management fee: 45bps
  • Active
  • Another entrant into the “core” fixed income ETF arena

9/22/2020: Vanguard ESG U.S. Corporate (VCEB)

  • Management fee: 12bps
  • Passive
  • Based on MSCI’s U.S. Corporate SRI Index
  • Competing v. iShares ESG Aware USD Corporate (SUSC) with management fee of 18bps.

Sources: ETFStrategy.com and Yahoo.com. Data as of 10/21/2020

Active or Passive Bond Funds:

Hype v. Facts, Key Takeaways

  • So far, 2020 is NOT really the year of active management
  • However, the ads for active management are compelling but data does not support the ads
  • Manager selection can be difficult, and performance persistence is not consistent
  • Smaller active funds performance can swing wildly due to tactical choices
  • Passively investing? Know your index!
  • Development of new ways to invest in the bond markets continues. Some are “me too” offerings and others are more unique that could give us better tools in the toolbox
  • Follow me on LinkedIn: www.linkedin.com/in/james-j-r-rieger-2018 or www.straighttalkaboutbonds.com

Analyst Disclosure

At the time of this writing, JR Rieger’s fixed income related holdings include individual municipal bonds both investment grade and high yield, insured municipal bonds, municipal bond money market funds and a position in the VanEck Vectors High-Yield Municipal Index ETF (HYD).

A Bit About Me

  • In 2018, I retired from S&P Global after a long career
  • To stay in the markets, I write and speak about the bond markets via www.straighttalkaboutbonds.com
  • Enjoy approx. 22.8k followers
  • All done without charging any fees – yes, its free!
  • I’m in the “gig” economy and provide consulting services for institutions on fixed income related challenges
    • Index providers – index design, underserved and new asset classes
    • Fund sponsors – index selection, fund positioning, mark-to-market issues
    • Analytics providers – evolving fixed income analytics
    • Bond data providers – creating new uses and new data capabilities
    • Legal & compliance issues – fixed income mark-to-market (pricing)
  • Heavy LinkedIn user: www.linkedin.com/in/james-j-r-rieger-2018

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