ETFs

In latest test, active managers outperform bond indexes

After a disappointing 2014, intermediate-term bond managers have found their footing.

Volatility is forcing bond indexes lower for the year, but active bond fund managers have been able to soften the blow.
Nearly three-quarters of intermediate-term bond funds, or 71%, are beating the Barclays U.S. Aggregate Bond Index, according to a new analysis conducted during last week’s anxious market by Morningstar Inc.
That compares to the disappointing performance of the funds in 2014, when nearly the same share of managers failed to even match the benchmark’s returns. Many managers were caught flat-footed by bad bets that assumed U.S. bond yields would rise.
Yet this year the benchmark U.S. 10-year Treasury has struggled. Yields, which move inversely to bond prices, hopped from a low of 1.64% on Jan. 30 to 2.48% last Wednesday. Since then, the bonds have staged a bit of a rally, trading back down at 2.36% midday Monday.
Despite the volatility, intermediate-term bond funds have largely held their value: They’re down just 0.05%, as of Friday, according to Morningstar. The Barclays Agg is down 0.32% for the year, as of Friday.
The fate of intermediate bond funds, a core holding in many adviser-built portfolios, matters to investors in hundreds of investment products. The funds manage $1.1 trillion in the U.S., according to Morningstar. All of the funds are calibrated to have moderate exposure to the risk posed by interest rates rising; most are benchmarked to the Barclays U.S. Aggregate Bond Index.
But the share of that money that’s moved into index-tracking mutual funds and exchange-traded funds has increased.
While bond funds have enjoyed a strong year of sales across the board, actively managed intermediate-term bond funds shed $77 billion over the two years that ended May 31. The index-fund counterparts took in $82 billion over that same period.
Today, actively managed funds control 68.5% of the assets in intermediate bond funds. That’s down 7.8 percentage points from two years ago.
Many of the advisers who moved money out of Pacific Investment Management Co. funds after the exit last year of founder Bill Gross parked it in index funds while they selected new managers. That sent sent billions of dollars to the Vanguard Group., BlackRock’s iShares and Fidelity Investments.
Now, some have decided to keep their money in index funds.
Last month the greatest beneficiary of the move to index bond funds — the Vanguard Total Bond Market Index Fund (VBMFX) (BND) — surpassed the Pimco Total Return Fund as the world’s largest bond fund. The Pimco fund was managed by Mr. Gross, who is now a portfolio manager at Janus Capital Group Inc.
The teams who have risen this year include some of the largest fund managers in the space. Mark R. Kiesel, Mihir P. Worah and Scott A. Mather, who took over Pimco Total Return (PTTAX) from Mr. Gross last year, staged a comeback. So, too, did Dodge & Cox Income (DODIX), whose team includes the firm’s CEO, Dana M. Emery, and J.P. Morgan Core Bond (PGBOX), which is managed by Douglas S. Swanson and Christopher J. Nauseda. Most of those fund’s share classes top the Barclays Agg return.
Other top managers have been right last year and this year. They include DoubleLine Capital’s Jeffrey Gundlach, who bet correctly on yields and manages the Total Return Bond Fund (DLTNX), as well as the team that manages the Western Asset Core Plus Bond Fund (WAPAX).
Don Bennyhoff, a senior investment analyst for Vanguard’s Investment Strategy Group, said managers have achieved success by buying lower-grade bonds than the index.
“On average they have lower-quality bonds in the portfolios. That’s a benefit for them, in one regard, because the higher income from the bonds results in lower duration,” or interest rate sensitivity, said Mr. Bennyhoff. “You are trading a little bit lower interest-rate risk for a little bit higher credit-rate risk. Those risk measures should be decided in combination.”
He said properly diversified portfolios of index funds, over the long run, have performed well.
“It’s actually paid off quite nicely,” he said. “People have been bearish on interest rates for quite some time.”
Julien Scholnick, a portfolio manager at Western Asset Management Co., said the market was positioned for a June rate hike by the U.S. Federal Reserve that never ended up coming. But his team felt the strength of the U.S. dollar and collapse in oil prices would depress inflationary pressures and give central bankers room to delay increases.
“We had a different fundamental view than the market and the pricing was such that there was an opportunity to take a position,” said Mr. Scholnick, whose firm is an affiliate of Legg Mason Inc.
The firm’s fund is in the top 17% this year for its 0.37% return, as of Friday. It also ranks in the top 3% for 2014 and in the top 9% over five years.
Mr. Scholnick said positive economic growth, low inflation and ongoing easy monetary policy around the world bodes well for high-yield bonds. But he said they’ve been careful to balance credit risks the team takes with exposure to long-duration U.S. Treasuries.