Morningstar Magazine - August/September 2018 - 31

Spotlight

Fixed Income

Raising the Bar for Active Bond Managers

38

Priced to Fail
Fees eat away at bond funds'
excess returns.
BENCHMARK

Mara Dobrescu, James Li, and Matias Möttölä

The typical active fixed-income fund manager
struggles to beat the fund's benchmark
after fees. As low-cost passive options become
more available in the fixed-income space,
investors need to be able to assess the relative
merits of active and passive bond funds
to make informed investment decisions. What
are an investor's odds of selecting an
active fund that is likely to outperform its
benchmark after fees? In which categories is it
preferable to choose a low-cost passive
option instead?
To answer these questions, we present a framework
for fixed-income funds based on historical

excess return distributions in 25 Morningstar
Categories. Our study spans nearly 16
years, January 2002 to October 2017, and includes
funds from Morningstar's U.S. and Europe, Asia,
and Africa categories.
Results show that, although the median active
manager can beat the benchmark in
several categories before fees, net-of-fees median
returns were negative in all 25 categories
( EXHIB IT 1 ). Unfortunately, most bond funds are
priced to fail. Their fixed fees were in
line with, or sometimes even above, their
historical margin of gross-of-fees outperformance,
thereby destroying the value added by managers.
The percentage of funds that managed
to perform at least as well as the index ranged
from a meager 10.5% to 49% depending
on the category.

global.morningstar.com/Morningstarmagazine

31


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Table of Contents for the Digital Edition of Morningstar Magazine - August/September 2018

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