Survey: Schemes favour active management for fixed income

The growing trend for schemes to seek an active approach on fixed income investing goes against the general murmur for a tighter rein on fees. Active fixed income has become of much greater importance, not only in matching liabilities, but also in the expectation it will produce returns.

A big theme in the feedback from the 44 schemes who completed our survey in August was the expectation that finding outperformance in fixed income would be easier than in equities – or just easier full stop.

The greater certainty around the core fundamentals of fixed income is creating more faith that fund managers can outperform in the maelstrom of market shocks, unlike in equities, where markets are more easily spooked.

Bold approach to active management

The responses to the question ‘To what extent would you favour active management for some fixed income asset classes? Which are these and why?’ produced a surprisingly emphatic response from close to half of the survey participants, and from schemes of all sizes.

The comments were dominated by a belief in market inefficiencies that can be exploited by skilled managers. While it is never stated, there is an implicit belief that spotting these inefficiencies is easier in fixed income.

This belief is held highest by the larger schemes. The investment manager of a £15bn fund said they had done it to “exploit opportunities and market anomalies”, while the investment director of a £4bn scheme said: “I would always tend to favour active bond management as bond indices tend to have a bias towards issuance, which is not intuitively attractive.”

A manager of a £1.25bn scheme compartmentalised his beliefs: “Corporate bonds – manager skill is to avoid the defaults. Absolute return – as manager skill needed to generate the return. Emerging market debt – imperfect market can offer opportunities.”

Elsewhere, faith in market inefficiencies were found in comments such as “distortions open up opportunities for skilled managers”, “there are sufficient market inefficiencies in non-government securities to justify active management,” and “for corporates bonds, it is generally possible to outperform indices”.

An active management approach was also seen as desirable for reducing volatility. The head of pensions for a £200m scheme said: “I favour active multi-strategy investing, which in theory enables the fund to perform whatever the economic conditions.”

The trustee of a £13m scheme said his scheme needed it to help with duration matching, while another favoured it simply because it worked the managers a little harder.

Cautious approach

For many, active management is strictly only for some parts of their fixed income portfolios. A few went into some detail about the logic behind this.

The manager of an £11bn scheme said: “Our approach is to have a passive core of mainstream fixed income – ie global government bonds and some global corporate exposure, together with a couple of active mandates managed on a global absolute return basis and covering the whole spectrum of fixed income opportunities. Our split is 50% active and 50% passive.”

Another interesting response came from the manager of an £8bn scheme, who picked up a familiar theme about emerging market debt benefiting from an active approach, but highlighted the eurozone for this approach too.

He explained: “Whereas equity investing is mainly about picking winners, bond investing is mainly about avoiding losers. So where there are plenty of losers, there is more scope for active fixed interest management to add value.”

For some, the cost of active management made sense for corporate bonds as a means of avoiding default risk. For others, it was treated as a necessary evil for the most exotic forms of fixed income.

Can't see the benefits

Strictly, the schemes that do not have active management of fixed income often have no call for it – it is not that they oppose it per se. Full reasons were not always given, but it seems likely it is less necessary for schemes close to full funding.

“We use fixed income to match cash flows so we have little active management,” said the manager of a £500m scheme, while the manager of a £1bn scheme said: “We use passive management for fixed interest – there is very little added value to be gained from active management of UK gilts and A-rated corporates.”

The member-nominated trustee of a £13m scheme gave their reason as being too small to appoint active managers. Then there are others who are simply dissatisfied customers.

The head of investments for a £1.5bn scheme said: “The fund has invested in actively managed corporate bond mandates in the past, which have underperformed, so the majority of this has been moved to passive.”