At Bramshill Investments, an asset manager offering absolute return solutions in fixed income and income producing assets, clients often ask us our perspectives on various sectors or vehicles in the fixed income spectrum. Lately, we hear more and more questions around passive investing in fixed income, which we believe is a flawed approach. A recent article in Pensions and Investments also presented some of the challenges of passive investing in fixed income.
Thought it might be helpful to share our market insights on why we believe passive investing in fixed income to be a sub-optimal approach.
- Passive investors are relegated to a fixed duration at all times. For example the Barclays U.S. Aggregate index has a duration of approximately 5.9 years. Therefore, a passive investor has much more exposure to interest rate volatility than what an active investor can accomplish.
- Fixed income indexes are market weighted. Therefore, passive index investors have their greatest exposures to the largest issuers of debt. This is counterintuitive. Active investors can invest in companies with leverage that is declining, balance sheets improving, not deteriorating.
- Fixed income indexes have set allocations to various sub-sectors. When there is an opportunity in a sub-sector which has deteriorated in price, passive investors have no ability to take advantage of such opportunities.
- Passive investors cannot take advantage of relative value in cap structures. If bond issues don’t meet the minimum threshold size, prices can be negatively impacted as indexed buyers cannot hold the bonds. This creates a potential edge for active managers with the ability to analyze the risk profile and buy smaller-cap bonds which are liquid and actively traded when there is a significant relative value discount across the same cap structure.
The challenges with passive investing in fixed income have led clients to pair Bramshill’s core plus strategy alongside their fixed income ETF / core exposure as a tactical complement. For additional information, please read our market insights in the recent Bramshill commentary which discusses the sectors/asset classes where we see the best risk/reward opportunities in fixed income.
