Noneconomic market participants, constantly changing index, and more have helped active fixed-income managers beat their passive peers, says PIMCO's Jamil Baz.
By Jeremy Glaser | 09-08-17 | 02:33 PM | Email Article

Managing director and global head of client analytics at PIMCO Jamil Baz started the final day of the Morningstar ETF Conference with an argument about why active investing works better in fixed-income than equity markets.

Jeremy Glaser is the Markets Editor for Morningstar.com.

The conversation with Morningstar's Miriam Sjoblom centered on a paper that Baz and his colleagues at PIMCO published in April.

Baz presented data that two thirds of active bond mutual funds and ETFs beat their passive counterparts over the last 10 years, a finding he described as "striking." For active equity funds only one third were able to outperform. He said that these findings held across all time periods that they studied.

Importantly, this outperformance holds when comparing managers against actual investible passive products and not the index itself. Baz explains that during periods of illiquidity (like during the financial crisis) the pricing of the bonds on the index doesn't represent the actual prices traders can get in the market. This has led to underperformance of active funds, but it also created even deeper underperformance of fund that there were trying to replicate the index.

Why have active fixed-income managers had success? One of the major drivers according to Baz is that half of the active bond market is made up of noneconomic players like central banks and insurance companies. These actors are buying bonds to execute quantitative easing programs or to match long-dated liabilities not to just maximize returns. He said that the cost of these constraints is a "transfer of alpha to active managers."

Another factor is that the turnover of bond indexes is much higher than for stocks, creating more opportunities to beat the index. The S&P 500 has only 4% turnover every year, while the Bloomberg Barclays Aggregate sees 40% turnover.

Add the ability of active managers to deploy active tilts (like having longer duration), purchase securities outside of the index, trade in options and trade different styles (value momentum) and Baz says you can see how bond managers have been able to turn in a good track record.

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Jeremy Glaser does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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