Active outperformance over such a lengthy period, spanning turns in the credit cycle, suggests factors at play beyond an emphasis on credit. Indeed, active managers have many other levers for seeking to generate alpha, such as sector rotation, out-of-benchmark allocations, duration positioning, security selection, and (in the case of global strategies) country and currency selection. These noncredit levers may also mitigate drawdowns during credit-adverse environments.
That said, credit overweights have clearly helped boost excess returns delivered by active managers over most periods — the great exceptions in the past 20 years being the global financial crisis (GFC) and COVID pandemic. Recouping of the spread widening emerging from these drawdown periods compensated for active managers’ shortfalls versus index returns in 2008 and early 2020. While the median active manager’s performance versus the index tends to be positively correlated to credit spreads — outpacing the index when spreads narrow and lagging when spreads widen — periods of underperformance have often been short-lived and typically outweighed by longer stretches of outperformance.
Reason #2: Market structure
Fixed income markets tend to be fragmented and opaque, prone to experiencing volatile liquidity. However, these features may benefit thoughtful investors by increasing the premia they can earn through portfolio implementation and active management (Figure 2).
Fragmented: Unlike equity markets, there is no “central” fixed income exchange. Instead, securities are still traded “over the counter” (OTC). This often requires a trading desk to strategically plan how it will either buy or sell a bond, allowing the implementation aspect of investing to potentially add value. Moreover, issuers may have different bonds in various parts of their capital structure or in varying currencies and maturities. A single corporate or government issuer may have numerous individual bonds, each with different terms and conditions. That can mean the risks and rewards differ as well. A passive exposure does very little to distinguish among those individual bonds.
Noneconomic actors: Some key participants in fixed income markets are looking to achieve objectives other than a rate of return. These include central banks and the US Treasury, along with commercial banks and insurance companies that may be subject to investment constraints imposed by the regulatory framework. Hence, these counterparties are often not trading based on valuations, leaving room for active investors to purchase or sell bonds at opportune times.
Liquidity and balance sheet: Reductions in dealer balance sheets following the GFC have made liquidity more variable across fixed income markets. Given that there is no central fixed income venue, investors rely on dealers to serve as counterparties for trades and to hold inventories of bonds. The reduced ability of a dealer to “intermediate” or serve as a place to store inventory means bond prices can be influenced by the noneconomic actors, providing the opportunity for an active investor to supply liquidity when traditional intermediaries cannot and to do so more effectively than passive investing.
Implementation: Fixed income markets provide a number of ways for skilled practitioners to add value through implementation, many of which are not replicable in passive terms. Issuer, CUSIP, and maturity are all important facets of a decision. In addition, active investors can decide whether the exposure looks better in cash (“funded”) format or through derivatives such as futures (“unfunded”) and can seek to exploit differentials between the two. Similar dynamics exist for currency markets, where lending dollars via the cross-currency basis market may deliver robust risk-adjusted returns. Over time, these and other tactics have often translated into superior results versus passive exposure.
FAQs
Active fixed-income management not only offers potential for enhanced returns but can also add value by aligning an investor's objectives with risks in several key areas—market structure, credit deterioration, dislocations, and dispersion—where index-tracking approaches may fall short.
What are the benefits of fixed-income? ›
Fixed-income investments offer investors a steady stream of income over the life of the bond or debt instrument while simultaneously offering the issuer much-needed access to capital or money.
What you need to know about fixed-income? ›
Fixed-income securities provide a fixed interest payment regardless of where market interest rates move. An investor that purchased a bond paying 2% per year will lose out on income if market interest rates rise above that level and the investor's money is tied-up in the 2% bond.
Why now for fixed-income? ›
Look for rate-sensitive fixed income
In general, prices rise as yields fall in fixed income. So, investing in higher-yielding fixed income today could capture yield with the potential for positive price performance should market yields continue to fall, tracking cash investment yields lower along with Fed rate cuts.
What does someone in fixed income do? ›
Living on a fixed income generally applies to older adults who are no longer working and collecting a regular paycheck. Instead, they depend mostly or entirely on fixed payments from sources such as Social Security, pensions, and/or retirement savings.
What is an example of a fixed income? ›
Bonds, such as U.S. Treasuries and corporate or municipal bonds, are traditional types of fixed income investments. Investors may also consider mutual funds and ETFs that hold fixed income investments.
What are the five factors affecting fixed capital? ›
Ans : There are many factors affecting fixed capital. Some include diversification, joint ventures, growth prospects, and production techniques. Ans : Some of the factors that affect working capital include the nature of the business, operating efficiency, availability of raw materials, and competition level.
What are the problems with fixed income? ›
Fixed income securities also carry inflation risk, liquidity risk, call risk, and credit and default risks for both issuers and counterparties. Any fixed income security sold or redeemed prior to maturity may be subject to loss.
How to live well on a fixed-income? ›
7 Smart Ways to Live Well on a Fixed Income
- Live below your means. This maxim has never been more important than right now. ...
- Micromanage your budget. ...
- Avoid adding new debt. ...
- Consider moving for tax savings. ...
- Downsize to a smaller place. ...
- Have fun for free. ...
- Earn extra money on the side.
A fixed-income bond can be valued using a market discount rate, a series of spot rates, or a series of forward rates. A bond yield-to-maturity can be separated into a benchmark and a spread.
Fixed income refers to any type of investment under which the borrower or issuer is obliged to make payments of a fixed amount on a fixed schedule. For example, the borrower may have to pay interest at a fixed rate once a year and repay the principal amount on maturity.
What is the goal of fixed income? ›
Preserve capital for more risk-averse clients. Generate income that can compound over time to build wealth and help clients pay for expenses. Lock in higher yields and soften the risk of remaining in cash if rates change.
What are the pros and cons of fixed income? ›
The pros and cons of fixed-income investing
| Pros | Cons |
|---|
| Provide investors with stable, predictable returns | Typically generate lower potential returns than stocks |
| Experience much less volatility than stocks | Come with interest-rate risk, as bond prices fall when market interest rates rise |
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The factors that affect the bond markets and interest rates are very complex. Economics, monetary and fiscal policy, business conditions, international trade, currency movements, and capital flows all affect market interest rates.
Are fixed-income funds good? ›
Fixed deposits, as they are commonly known, are one of the most secure kinds of investment. Depending on the investor, these fixed-income instruments can be obtained for both short and long terms.
Why is fixed-income better than equity? ›
Difference Between Equity and Fixed Income. Equity income refers to making an income by trading shares and securities on stock exchanges, which involves a high risk on return concerning price fluctuations. Fixed income refers to income earned on deposits that give fixed making like interest and are less risky.
What are the advantages of income bonds? ›
Because bond issuers are repaying debt over time, bonds can also provide steady income, which can be a real benefit if you're looking for a predictable stream of money—for instance, to help with living expenses in retirement. Municipal bonds can even provide a tax-free income stream.
What are the benefits of a fixed annuity? ›
5 advantages of fixed annuities
- Your premium is protected. ...
- Fixed annuities have a guaranteed minimum interest rate. ...
- The earnings from a fixed annuity are tax-deferred. ...
- You can have reliable retirement income. ...
- Fixed annuities are easy to understand. ...
- Their growth is sheltered from the market.
