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Fixed Income with Harley Bassman

Active managers take the lead

in rocky markets

Volatile markets are an active manager’s time to shine.

In fixed income, widening credit spreads, slashed interest rates and downgrades all represent opportunities for active managers to differentiate themselves. A fresh wave of active bond funds is also expected following a new ETF rule allowing actively-managed exchange traded funds (ETFs) and recent SEC approvals for non-transparent ETFs. And with new tools and data to help analyze fixed income markets, the opportunity is clear.

Investment grade credit rebounded in April after negative returns in March, with performance differing sharply by quality and sector. The excess returns on AA-rated corporate debt was ~4% in April after a near -7% excess return in March, while BBB excess returns were ~6% in April versus almost -14% a month earlier. Fallen Angels, or bonds which have lost their investment grade status, hit a stunning $91 billion in March, with an additional $75 billion in April.

Against this broad repricing of risk, passive investment strategies appear more constrained by their mandates and exposure to potential downgrades. By contrast, active managers can take broader action to preserve capital and avoid excessively leveraged issuers. The sheer range of securities ineligible for inclusion in indices widely used by passive funds - such as private placement and floating rate issues - also gives active managers more flexibility to tailor fixed income portfolios. And in a complex asset class, those managers who can apply tools to extract insight from an onslaught of associated data stand to benefit from an information advantage.

This advantage may be gained using tools that help monitor and manage risk. Asset managers can project the differences between active returns versus a benchmark using hypothetical yield curves and credit spread changes with Scenario Analysis. “What-If” analysis can enable asset managers to monitor risk exposure across single or multiple portfolios using pre-trade analysis. And users can also utilize performance attribution tools to analyze historical performance versus a benchmark to determine where value was added. The use of robust indices is also critical, so active managers can gauge their relative exposure to securities and asset classes.

Regulatory change further supports the growth of active bond funds. ETFs are popular for their low-costs, tax benefits and transparency. Yet for some fixed income managers, a desire to keep their strategy opaque for competitive reasons has dissuaded them from using this structure. Now, in addition to actively managed ETFs, the SEC has given approval for non-transparent ETFs. This will further support growth in the $4 trillion sector, which saw over half of all inflows to fixed income funds last year.

As risk repricing continues, managers that can analyze data and act on opportunities stand to do well. More broadly, a risk-averse backdrop means a chance for bond managers to tap new client segments and develop new products. In a complex asset class, the foundation for success remains: an ability to manage risk and process an onslaught of data - where having the right tools and analytics can mean a critical edge.