Why Might Actively Managed Bond Funds Underperform their Benchmarks?

Over the long term, actively managed bond funds have not outperformed their benchmarks  as evident in the SPIVA U.S. Scorecard for year-end 2014.  In a recent blog post, I analyzed the performance data of this scorecard.  Many wonder what might be causing the results to be one-sided.  For example, in a recent post on Practical Stock Investing, the author states that “the numbers are stunning” but questions what the reason is for this  “woeful showing.”   Here  are some possible explanations of why actively managed bond funds might underperform their benchmark:

  • Interest rate call. Sounds easy but it isn’t and getting the timing right is equally as critical.
  • Duration risk. A component of the right interest rate call is managing duration risk.  What is the funds duration target?  How will it achieve that target and when?
  • Sector allocation.  For multi-asset class funds and corporate bond funds, sector weights can make a difference.  When to reallocate and place more/less weight in select sectors?
  • Credit selection. A more pressing issue for corporate bond funds includes which credits should the fund invest in, how much to invest in them and when to do so?
  • Turnover & transaction costs.  Indices do not take into account the costs of transactions. Turnover in a fund translates into transaction costs, the higher the turnover, the higher the ‘friction’ or erosion on returns.
  • Timing.  Timing is mentioned in almost all of these possible explanations.

There may be other explanations but these are the ones that I believe have the most impact.

The posts on this blog are opinions, not advice. Please read our disclaimers.

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