BlueMountain Capital Makes the Case for Active Management of Bonds
June 19, 2019
Bond fund investors have realized “higher returns owning active funds than they would have owning passive funds” – so says BlueMountain Capital in their report, “Looking for Easy Games in Bonds.”
The shift to passive in stocks has received more attention than that in bonds, most notably because it has been more dramatic. However, according to the report, cumulative flows have been positive for both active and passive bond funds. Over the past ten years, flows into active bond funds have been roughly $935 billion and flows into passive bond funds have been about $960 billion.
Persistence in Performance
Simply put, active bond managers that outperform the benchmark tend to do so with some consistency. A significant percentage of actively-managed bond funds outperform passive alternatives and, in some investment categories, that percentage seems to increase with time.
All markets are highly competitive, the report points out. But the “persistence and standard deviation of alpha suggest that the opportunity to find managers who may outperform is greater in bonds than in stocks.”
Generating positive alpha requires applying skill through a robust process and an ability to find inefficiently-priced assets.
Sources of Outperformance
BlueMountain has seen that it is difficult to build a fund that closely tracks the Bloomberg Barclays US Aggregate Bond Index. The Index has more than 10,000 securities, making an exact replication virtually impossible. But according to their report, this difficulty creates opportunity. “Refinancing, maturities, and issuance present ways for active managers to beat the benchmark.”
It is important to add that “most of the outperformance of active bonds is attributable to traditional risk premiums, including term, corporate credit, and emerging markets risk.” This is consistent with other papers on the topic. BlueMountain theorizes that active managers have access to opportunities that passive managers do not (e.g. dynamics around issuance).
The issuance of new securities is a critical source of this opportunity, suggests the report. Issuance is far more active in the bond market vs stock market, bonds mature whereas equities are perpetual. At the same time, institutional bond investors are often able to do so at a discount from underwriters.
The Bottom Line
Leveraging a framework developed by professors Jonathan Berk and Richard Green which looks at cumulative gross profit, to gauge the value that active managers generate, BlueMountain Capital answers a crucial question in investing – How much opportunity is there for active managers to capture alpha?
Active managers continue to contribute to price discovery and liquidity, which are vital. While flows to both passive and active bond funds continue unabated, it may be reasonable to assume there is still plenty of opportunity yet to be discovered.
The IAA formed the Active Managers Council to foster education and thought leadership regarding active management, to curate and sponsor research on active and passive management. As the active/passive conversation continues to evolve, the need for education is apparent. For more insight please visit the Council’s Research & Thought Leadership section to review a growing library of content on active management.