There is an investment meme that active managers in fixed income are able to beat their benchmarks given the wide variety of strategies employed and the significant dispersion in markets debt offering. There are able to achieve alpha where equity managers fail.
A closer look suggests that the active managers have a common approach to beating their benchmarks, increase their exposure to credit. After accounting for this added credit exposure, there is no real alpha production. Put differently, hold an active fixed income manager and you are just getting overexposure to credit risk premia.
A closer look suggests that the active managers have a common approach to beating their benchmarks, increase their exposure to credit. After accounting for this added credit exposure, there is no real alpha production. Put differently, hold an active fixed income manager and you are just getting overexposure to credit risk premia.
This is the conclusion from an AQR paper on fixed income managers across US aggregate, Global aggregate, and Unconstrained managers. (See "Active Fixed Income Illusions" Brooks, Gould, and Richardson 2019.) This result is not much different than what I have seen from other research that has looked at this issue. The easiest way to beat the benchmark is to load up on exposures that have higher carry through spread risk. Within the credit sector, there is a bias toward BBB-rated debt over higher-rated bonds.
What is novel about this paper is that it investigates the cost of following this active strategy. Holding more credit will provide higher unconditional returns, but if an investor focuses on the conditional returns during bad equity quarters there is a less benefit from fixed income diversification than what would be received from just holding the benchmark. This result may be surprising but should be expected. If the active managers increase credit exposure, the active portfolio will be more equity sensitivity and less downside protection.
Now a finer look may reveal active return production, but it seems reasonable to see if there are cheaper ways of getting this excess return through just taking marginal credit risk. Perhaps exposure to a fixed income benchmark index with a credit risk premia overlay could provide value-added, or a Treasury portfolio mixed with a credit index?
Now a finer look may reveal active return production, but it seems reasonable to see if there are cheaper ways of getting this excess return through just taking marginal credit risk. Perhaps exposure to a fixed income benchmark index with a credit risk premia overlay could provide value-added, or a Treasury portfolio mixed with a credit index?
The conclusion for fixed income active investing is not different than active equity investing. If the value-added is based on just increasing exposure in what is not in the benchmark, there are less expensive ways of achieving this goal.
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