Morningstar Magazine - August/September 2018 - 7

Letter From the Editor

The Price Must Be Right

Jerry Kerns

Follow Jerry on Twitter
@jerrykerns

To the researchers at Morningstar, the incessant
active-versus-passive debate has always been
more about fees than whether one type of
investing is fundamentally superior to the other.
When making the choice between actively
managed offerings and index funds, investors
should focus on costs more than investing dogmas.
After all, our research has shown over and
over again that there is no surer indicator of a
fund's performance than its price tag.
Nowhere are expenses as crucial to consider
than in the universe of fixed-income funds.
The range of returns between the top-performing
bond funds in a category and the cellar
dwellers is much tighter than it is with equity
funds. Plus, with yields near historic lows
across bond sectors in recent years, fees have
eaten up an even larger share of returns. It's not
surprising, then, that the typical active bond
manager has had a difficult time beating
his or her benchmark after fees. And fixed-income
investors have noticed. They are increasingly
turning to the expanding menu of low-cost
passive funds to get their bond exposure. But is it
smart to invest in bond index funds across
categories? Are there areas of the bond market
where it still pays to be active? In this issue,
we seek to answer these questions.

traded bond funds struggled to match their
benchmark in certain categories. In these areas,
investors may stand a better chance by choosing
an active fund-if the fees are low enough.
One category where active managers have had
recent success has been in the intermediateterm bond category. In our second Spotlight article
("Raising the Bar for Active Bond Managers,"
Page 38), director of passive strategies Alex Bryan
dives into the reasons why and finds that it
has a lot to do with the category benchmark,
the Bloomberg Barclays US Aggregate Bond Index.
The index doesn't completely represent the
category's diversity. The index's credit-risk
exposure is low, for example, something active
managers can exploit for an easy win over
the index. Bryan sought to get a sense of whether
active managers in the category are exhibiting
true skill or just earning compensation for building
exposures to common risk factors. He found
that often investors can get cheaper exposure
to these risk factors through ETFs, although there
are active bond managers who do outperform
after controlling for common risk factors. In these
cases, the alpha would be worth it-if the
price is right.

In our lead Spotlight article ("Priced to Fail,"
Page 31), manager research analysts Mara
Dobrescu and Matias Möttölä, with quantitative
analyst James Li, studied the historical
excess returns of funds in 25 global fixed-income
Morningstar Categories. Their study spanned
nearly 16 years of data. The analysts found
that the largest explanatory factor for chronic
underperformance of bond funds versus
their indexes is the impact of fees. The median
fund in 13 of 25 categories beat its benchmark-
gross of fees. After fees, the median fund
underperformed in all 25 categories. Importantly,
the researchers also found that even exchange-

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7

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

Contents
Morningstar Magazine - August/September 2018 - Cover1
Morningstar Magazine - August/September 2018 - Cover2
Morningstar Magazine - August/September 2018 - 1
Morningstar Magazine - August/September 2018 - 2
Morningstar Magazine - August/September 2018 - Contents
Morningstar Magazine - August/September 2018 - 4
Morningstar Magazine - August/September 2018 - 5
Morningstar Magazine - August/September 2018 - 6
Morningstar Magazine - August/September 2018 - 7
Morningstar Magazine - August/September 2018 - 8
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