The Active Advantage: Why High-Yield Bonds Benefit from Active Management

But don’t count out active management altogether. In some sectors, active can and does win out, providing better returns than passive strategies.

One of the best examples happens to be junk or high-yield bonds. That’s the gist according to a new PineBridge study. Investors who have chosen active management for their junk bond exposure have handily beaten their passive peers. Given the surge in new active ETFs covering the space, investors should take notice.

Despite its name, there isn’t anything passive about passive investing. People create indices and benchmarks. Teams of analysts pick and choose what goes into an index and what weighting security will have. So, they are not perfect by any means. The Dow Jones Industrial Average is often criticized for its price weighting scheme, which allows a few stocks within its universe to have a big pull over the index.

There are problems with many fixed income indices as well. Those issues come down to how the index is constructed.

Most stock indices use market cap to determine placement and weighting. When designing the first batch of fixed income indices, creators followed their stock market sisters. Many popular bond indices—such as the Bloomberg Barclays Aggregate Bond Index (Agg)—use a market cap weighting system as well. That is, the firms with the most debt get a higher place in the index. Essentially, you’re rewarding the biggest debtors with more pull on the index

For an investment-grade-based index like the Agg, that’s not necessarily a huge deal. Treasury bonds are as good as gold, while many investment-grade issuers like Apple or Walmart are statistically not going to default any time soon.

Moreover, there’s little ‘secret’ information about these types of bonds. Hundreds of analysts cover Microsoft, while the Federal Government’s debts, taxes, and finances are also very well covered. Liquidity is ample as well for these types of bonds.

But moving down the credit quality ladder, market-cap-weighted indices start to hinder performance.

Again, those with the most debt could be riskier than those with only a little outstanding. At the same time, junk bonds trade on the OTC exchanges, where liquidity is an issue. Meanwhile, the junk markets tend to comprise smaller firms whose information isn’t as easy to obtain.

For active managers in the high-yield space, this is a godsend. Active fixed income managers can do credit analysis, dig into bonds, find those trading at discounts to par, hedge interest rate risk, etc. With this fact in tow, they have a real opportunity to outperform.

And outperform they do. Digging into the data, the average high-yield manager beats their benchmark by a decent margin.

According to asset manager PineBridge, active managers in the high-yield space beat passive ones over trailing one-, three-, five-, and 10-year periods. Looking at data from NASDAQ subsidiary eVestment of active managers versus Morningstar’s data of passive high-yield funds, the study showed that active managers have outperformed by as much as 0.7 basis points per year. This chart sums up their findings. ¹

Source: PineBridge

Remember, unlike stocks—which can surge 20%+ in one year—bonds are a game of inches. So that 0.7 basis point outperformance is pretty significant.

What’s interesting about PineBridge’s study is that those extra returns have come in at lower risk profiles. Thanks to in-depth credit research, the average active junk bond manager has less risk—as represented by Sharpe ratios—than passive funds. Investors are getting better returns while not putting themselves at greater risk.

Better still, those returns are net of fees. When looking at fee data, PineBridge shows that investors in passive fixed income funds don’t receive the same sort of return boost that passive equity fund investors get when migrating from active strategies. For example, the fifth percentile breakpoint for fees in Morningstar U.S. Large Cap Blend ETF category is just 0.05%. This compares to 0.24% for eVestment Large Cap Core Peer Group. That’s a big difference in cost. For fixed income, the numbers for all percentiles are very close to each other when comparing passive to active management of junk bonds. There’s no extra boost to be had.

Thanks to poor index construction, lower liquidity, and the ability of high-yield managers to do credit research, the choice is clear. Investors looking to add a touch of high-yield bonds to their portfolio are better suited to active strategies than they are to passive ones. And just to hit the nail on the head, PineBridge compared active managers’ returns versus the three big passive ETFs: iShares Broad USD High Yield Corp Bd ETF, iShares iBoxx $ High Yield Corporate Bond, and SPDR Bloomberg High Yield Bond ETF. Over the longer haul, active beat these three popular funds.

The biggest win is that active ETFs have only enhanced active management wins in the space. Because of the lower cost to run and the ability to remove capital gains, active junk bond ETFs have the ability to produce even better results.

These funds are selected based on their ability to access high-yield bonds with an active touch. They are sorted by their YTD total return, which ranges from 1.3% to 4.7%. Their expense ratio ranges from 0.22% to 1.02%, while they have AUMs between $50M and $5.63B. They are currently yielding between 5.7% and 8.6%.

For high-yield bond investors, active management is the way to go. Data supports better returns at lower risk profiles by using active ETFs and management to get your junk bond fix. Investors considering the asset class may want to skip the passive options and choose active instead.

¹ PineBridge Investments (April 2024). High Yield Bonds Call for an Active Investing Approach. Here’s Why.