The fixed income industry looks set to replicate a revolution in equity investing as new fund managers usurp big names such as Bill Gross and Jeffrey Gundlach, who a decade ago dominated the bond market.
The latest mutual fund entrants range from cheaper passive vehicles that buy whatever the market has to offer, to more exotic products trading in a host of racy credit exposures. And, as such, they reflect what has unfolded in equity markets this century, with investors favouring cheap index-tracking funds at one end of a “barbell” investment strategy — with alternative assets such as private equity and hedge funds at the other.
As a result, the traditional actively managed mutual funds that sit in the middle of the risk and cost spectrum have lost much of their market share.
“The barbell effect we have seen for two decades in equity is now coming in earnest to fixed income,” says Huw van Steenis, vice-chair of consultant Oliver Wyman.
Van Steenis sees less expensive passive funds and relatively cheap active exchange traded funds benefiting at one end of the spectrum, and alternative vehicles, such as private credit and infrastructure debt funds, at the other. Again, traditional active mutual funds, “the muddling middle”, are the losers.
The data would appear to bear this out. Whereas, a decade ago, four of the world’s six largest bond funds were actively managed mutual funds, today, just one — the Pimco Income Fund — sits in a top six dominated by passive mutual and exchange traded funds, according to Morningstar data.
This shift has led to traditional actively managed mutual funds accounting for only 57 per cent of the combined fixed-income assets of all US mutual funds and ETFs — down from 74 per cent seven years ago, on Morningstar figures.
Active ETFs have been gaining market share, and their low fees — 0.4 per cent on average, compared with 0.65 per cent for active mutual funds, according to State Street Global Advisors — may be enough to ensconce them at the cheap end of the barbell.
It is a strategy that has gained some high-profile adherents, too. BlackRock chief executive Larry Fink said last year that “we used to talk about equity having more of a barbell effect. I think we’re starting to see that here in the bond market.”
This also helps explain the US money manager’s recent acquisitions of private infrastructure manager Global Infrastructure Partners and private credit manager HPS Investment Partners, building on its dominance as the world’s largest purveyors of cheap ETFs in other assets.
To van Steenis, the data tells the story. Six large alternative managers — Brookfield, Carlyle, Ares, Blackstone, KKR and Apollo — generated net new money growth of between 15 per cent and 40 per cent in their credit strategies in the year to June 2024, he notes, even as global long-only bond funds as a whole eked out growth of 1 per cent.
He speaks of a “Cambrian explosion of hybrid products”, such as a public-private fund courtesy of KKR and Capital International, and the plan by SSGA and Apollo to launch an ETF that would also combine these exposures.
“There is a lot of interest in that hybrid space,” van Steenis observes. “That is where I’m spending my time.” He believes traditional fixed income managers stuck in the middle “need to tune up their investment engines, innovate, or merge for scale”.
Kenneth Lamont, principal of research at Morningstar, broadly agrees that the barbell effect is taking hold, noting a “convergence of public and private assets” across the asset management industry.
“It doesn’t surprise me that there is a gravitation towards cheap funds. ,” Lamont says. “Regardless of what happens, that will continue.”
As for fund managers’ newfound fondness for more exotic private assets, Lamont attributes this, in part, to the higher fees they can charge for harder to access credit exposures. “The private market business is a more profitable business,” he notes.
Lamont, though, suggests that the bifurcation in demand witnessed in the equity market does not necessarily map neatly into fixed income.
One reason is that the structure of passive bond funds may not appeal to as many people as their equity equivalents.
“It’s not the same as equities: if you invest in a cap-weighted fixed income fund, it’s not like equities where you invest more in the largest companies,” he says. Instead, you gain exposure to “the most indebted companies”, which are “not necessarily” the ones you want to be most exposed to.
“The passive approach to fixed income doesn’t have quite the same theoretical backing as investing in an equity index,” Lamont concludes.
In addition, because of the vast number of instruments in many bond indices, fund managers typically cannot invest in them all, as they would with equities. So passive managers may use stratified sampling to mimic the performance of a wider index — and “you can argue that is a form of active management in its own right”, Lamont argues.
Perhaps, because of these factors, active bond fund managers have a slightly better record of beating their benchmarks compared with their equity market counterparts.
In recent years in Europe, for example, about half of actively managed bond funds have outperformed their passive equivalents over one and three years, and about a third have over five years, net of fees, according to Morningstar data.
This is markedly better than active equity managers. Only about a third of them have outperformed over one year, and only a quarter have outperformed over three or five.
Van Steenis accepts that “it’s a little bit easier to outperform a fixed income benchmark because you can add in some illiquid bonds”. Nevertheless, he says that “the potential outperformance is not saving the bulk of active fixed income mutual fund managers”.
Instead, “investors are flocking to ETFs”, which are “cheap, convenient and tax efficient in the US” — a trend he does not see reversing any time soon.
Read the full article here