Active Fixed Income Illusions

Abstract

Over the past 20 years, active fixed income (FI) managers have tended to deliver returns in excess of their benchmarks. This has generated a popular notion that active investing in fixed income markets is “easy.” The aim here is to assess the veracity of that notion. Across a broad set of popular active FI categories, this article finds that passive exposures to traditional risk premia (especially exposure to credit risk) explain the majority of FI manager active returns. The resulting implication is that, contrary to popular belief, traditional discretionary active FI strategies offer little in the way of true alpha and that traditional active FI strategies may significantly reduce the strategic diversification benefit of FI as an asset class. TOPICS: Fixed income and structured finance, performance measurement, fixed-income portfolio management Key Findings • Across US Aggregate, Global Aggregate, and Unconstrained categories, we find that a significant portion of fixed income manager outperformance can be explained by passive exposure to credit risk. • Credit exposure meaningfully reduces the diversification benefit of fixed income. During the worst 10 quarters for equities, active fixed income strategies have underperformed their benchmarks, at times significantly. • After allowing for persistent exposure to credit and to other traditional risk premia, active fixed income managers generate virtually no alpha. This result holds both for managers on average in each category and for individual managers.