The debate is still raging over active versus passive management when it comes to investment portfolios. Passive investments have continued to gather record inflows as investors have realized the power of low-cost indexing. The creation and widespread adoption of ETFs have certainly added to the appeal of indexing and passive investments. But there’s one area that active management may decidedly have the upper hand and finally put the passive/active debate to rest.
We’re talking about bonds.
Thanks to a new study from Morgan Stanley, the data definitely shows that active managers can beat their passive peers, and sometimes by a wide margin. With the study, the choice for bond investment is clear: active over passive. And active ETFs make this decision even easier.
Passive Investment Use Surges
While it was once considered heresy, passive investment has continued to become the go-to building block for many investors both big and small. Jack Bogle’s creation of the index fund revolutionized portfolio management. These days, trillions of dollars now sit in passive investment vehicles. And thanks to ETFs, that number has surged to over $12.2 trillion at the start of 2024.
This includes a hefty dose of passive investment in the fixed income space.
Like the S&P 500, the popularity and ease of use of the Bloomberg Aggregate Bond Index (Agg) and similar passive indices covering high-yield bonds and municipal bonds has brought indexing to the bond world. By and large, building a portfolio of individual bonds is hard and time consuming. With one ticker, investors can own thousands of bonds; in the case of the Agg, it’s over 10,000. It’s no wonder nearly $4 trillion sits in passive bond ETFs.
Like the equity space, those growing assets in the fixed income space have come from many active funds. Fund flows for actively managed bond mutual funds have continued to dwindle.
But investors should think differently about their bond holdings and do the reverse.
Morgan Stanley’s New Study
That’s the gist according to a new study by Morgan Stanley Investment Management (MSIM), which found that active managers in the bond and fixed income space have managed to crush their passive peers.
For the study, Morgan Stanley looked at the 327 active bond funds currently on the market. These funds hold in aggregate over $2.2 trillion. Breaking the funds into various categories and comparing them to their various sector benchmarks, MSIM found that active beats passive over 84 different rolling three-, five-, and 10-year periods. 1
When looking at taxable bond categories, the average active manager and fund managed to produce an average 121 basis points in extra return over passive managers for the three-year period. For five- and 10-year periods, the results were an average extra 112 basis points and 68 basis points worth of return, respectively. Looking at tax-exempt and muni funds, the extra active return was 68 bps, 53 bps, and 33 bps for the three-, five-, and 10-year periods, respectively.
On the whole and over the 10-year period, active funds outperformed in eight of the nine major Morningstar fixed-income categories for the full cycle. This chart from MSIM breaks down the return periods and the rolling returns.
Source: Morgan Stanley Investment Management
Perhaps the more interesting piece of Morgan Stanley’s study isn’t just about the extra returns active has over passive, but consistently scores those returns. MSIM dug into the so-called batting average of active managers and found that here, too, they managed to beat passive funds.
Over the 10-year period, active managers managed to exceed passive returns 87% of the time. However, in some categories, those consistent beats were 95% or more. For example, high yield muni managers managed to beat their index rivals 98% of the time. For junk bonds, the number was 95%. Perhaps what was most striking was that emerging market bond managers managed to beat passive returns 100% of the time for the 84 rolling ten-year periods.
The Why & Why You Should Go Active
With Morgan Stanley’s new study, we can finally put to bed the idea that passive is the only way to go when it comes to building a portfolio. For fixed income asset classes across the board, active is superior. The reason for the wins, according to Morgan Stanley, comes down to passive inflexibility and the ways an active manager can drive additional alpha.
Active managers can and do have the flexibility to take advantage of opportunities that arise as markets fluctuate. Passive funds can’t do that. Moreover, the sheer nature of the fixed income landscape and the ability to perform credit research can uncover opportunities that passive funds miss. Often indices are created with a focus of liquidity (i.e., betting on the biggest debtors).
Morgan Stanley provides an example within the emerging space. A manager here could seek to generate additional alpha “through country and security selection, currency management, trading and execution, and duration management.” A passive fund is stuck within the confines of its index.
As such, investors may want to give active bond funds a serious look for their portfolios. The best part is that active ETFs have now made active fixed income management a low-cost and easy proposition. Numerous funds in the space continue to launch as investors seek to get better returns.
Active Bond ETFs
These ETFs were selected based on their low-cost exposure to active bond management. They are sorted by their YTD total return, which ranges from -2.8% to 2.8%. They have expenses between 0.18% and 0.70% and assets between $3B and $23B. They are currently yielding between 4.4% and 9%.
| Ticker | Name | AUM | YTD Total Ret (%) | Yield (%) | Exp Ratio | Security Type | Actively Managed? |
|---|---|---|---|---|---|---|---|
| SRLN | SPDR Blackstone Senior Loan ETF | $4.36B | 2.8% | 9.0% | 0.70% | ETF | Yes |
| MINT | PIMCO Enhanced Short Maturity Active ETF | $9.7B | 2.2% | 5.1% | 0.35% | ETF | Yes |
| JPST | JPMorgan Ultra Short Income ETF | $22.8B | 1.9% | 5.4% | 0.18% | ETF | Yes |
| TOTL | SPDR DoubleLine Total Return Tactical ETF | $3.1B | -0.7% | 5.2% | 0.55% | ETF | Yes |
| BOND | PIMCO Active Bond ETF | $3.5B | -1.1% | 5.0% | 0.58% | ETF | Yes |
| DFCF | Dimensional Core Fixed Income ETF | $3.35B | -1.3% | 5.0% | 0.19% | ETF | Yes |
| FBND | Fidelity Total Bond ETF | $5.1B | -1.5% | 4.9% | 0.36% | ETF | Yes |
| FIXD | First Trust TCW Opportunistic Fixed Income ETF | $4.4B | -2.8% | 4.4% | 0.65% | ETF | Yes |
With Morgan Stanley’s new study providing plenty of evidence that active beats passive in a consistent manner, choosing the management style for your bond holdings could be a no-brainer.
The Bottom Line
Index funds have quickly become the choice for many investors to build their portfolios. But when it comes to bonds, they should be going active. A new study from Morgan Stanley shows that active constantly beats passive over the long haul when it comes to fixed income. That means active bond ETFs need to be on your investment menu.
1 MSIM (May 2024). Active Bond Managers Show Their Worth in a Turbulent Decade