Originally published in CNBC
By Sanjoy Ghosh
When the bond-fund heavyweight Pimco scuffles with passive investing guru John Bogle about the right approach to bond investing, it’s like watching a good prize-fight boxing match.
Pull out the popcorn and let’s see who we think will be the winner.
As a chief investment officer by trade, I love nothing more than an engaging debate between titans of the asset-management industry. And, as an investor, paying fees for active management and your retirement on the line, it pays for you to watch how this plays out as well.
To recap, Vanguard founder and passive investing patron saint Bogle took a shot at actively managed bond funds when he said passive investing was as preferable in bond markets as it is in equities. This was truly a hard knock to Pimco, whose own “bond king” Bill Gross had recently left the firm. Pimco’s flagship $200 billion-plus Total Return Fund has been lagging its own Barclays benchmark.
Initial reports have been that many bond investors who left Pimco when Gross left the firm were moving their money into ETFs. So Bogle’s comments were a bit of salt in Pimco’s wounds.
Pimco Managing Director James Moore fired back with a note titled: “Sorry, Mr. Bogle. But I respectfully disagree. Strongly.”
Moore makes the assertion that bond investing is different. New issuances are a larger portion of bond markets than IPOs and secondary offerings are in equity markets, and active management can capture the value there. He also asserts that bond ETFs are skewed by weightings that are based on the amount of debt companies or governments decide to issue.
Of course, this debate can get deep in the weeds pretty quickly. If we were to try to cut through the noise, one way to do so would be through the use of data.
And what that says is, that while the advantage may be to Pimco, to a degree they are both right.
For instance, S&P Dow Jones Indices latest scorecard, which tracks active versus passive investments performance across asset classes, found that many active bond funds do, in fact, underperform their index. For instance, in the mid-year scorecard issued in September, it found that the significant majority of actively-managed funds in the longer term government and longer-term, investment-grade corporate bond categories underperformed their benchmarks. Interestingly, in these same categories active managers had shown their largest outperformance in 2013.
According to Aye Soe, Senior Director, Index Research & Design at S&P Dow Jones Indexes, this highlights the difficulty in predicting the path of interest rates.
“In equities, it’s pretty clear. It’s very difficult for active managers to outperform. When it comes to fixed income, it’s not as clear cut,” she said in a phone call on Friday. She said that there were corners of the fixed-income market where active managers have been better able to beat benchmarks than others.
“High yield, the data says it’s better to go indexing,” she said. “And active managers also have a hard time beating benchmarks on senior loans.”
But then she says that there are other markets, such as municipal bonds, where she sees a definite benefit to active management.
As if this debate isn’t already difficult to unpack, there is also a third way. For instance, Rahul Diddi of Diddi Capital has a Diversified Target Yield Bond ETFs portfolio on the Covestor platform, which targets a consistent 5 percent to 6 percent annual income by actively managing a portfolio of fixed-income ETFs. He adjusts the allocations to capture performance in corners of the fixed income world, such as municipal bonds or emerging-markets currencies.
Overall, my advice in this current market, where there exists the risk of an interest-rate hike, there is a benefit to finding highly specialized managers who can steer your bond holdings through what could be some very tricky years as interest rates rise.
Commentary by Sanjoy Ghosh, chief investment officer of Covestor, an online investment-management company.