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Is Active Fixed Income Really Better?

In the first eight months of 2015, investors added $37 billion into fixed income ETFs compared to the $85 billion for equity ETFs. Though there are still a smaller number of highly liquid ETF choices for investors to consider, we think the driver behind the fund flow difference is that many investors believe that active management works better than passive with bonds.

However, according to S&P Dow Jones Index Versus Active (SPIVA) research, in the one-year period ended June 2015, the average active mutual fund in nine of the ten tracked active fixed income styles lagged the respective Barclays index. Though 69% of the global income mutual funds outperformed, this style was the lone outlier.

Meanwhile, a shockingly low 1.2% of government long funds outperformed the Barclays Long Government index and only 15% outperformed when looking back to five years. This certainly suggests to us that looking at the SPDR Barclays Long Term Treasury ETF (TLO) is appropriate since finding those hidden gems is a challenge. While there is a cost to the ETF, unlike the Barclays benchmark, we believe it is quite modest at 0.1%. The ETF offers a 2.8% 30-day SEC yield and has duration of approximately 17 years.

Meanwhile, only 10% of emerging market debt and 42% of mortgage-backed securities funds outperformed the outperformed the Barclays Emerging Markets and Mortgage-Backed Securities indices in the one-year period. Underperformance in emerging markets has persisted throughout the SPIVA study, with just 6% and 3% of all funds have success in the recent three- and five-year periods. Considering the Lipper average emerging market hard currency debt fund has a hefty 1.23% expense ratio that eats into returns, this should not be too surprising.

Some of the weaker performers, such as SEI Emerging Markets Debt Fund (SITEX), have an even higher 1.6% expense ratio. In contrast, DoubleLine Emerging Markets Fixed Income (DBLEX), has been a consistent outperformer aided by its relatively modest 0.90% expense ratio.

The tough year for active fixed income mutual funds is part of a broader trend. Indeed, just 36% of all domestic equity mutual funds outperformed the S&P 1500 index in the one-year period ended June 2015.

To keep up with ETF trends, follow me at @ToddSPCAPIQ or check out http://trymsatoday.com/

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