The Characteristics of Winning Bond Funds
This article originally appeared on ETF.COM here.
The U.S. bond market is one of the largest in the world, with managers controlling more than $2 trillion in assets. Given its size, an important question is identifying active bond fund managers that add value.
Markus Natter, Martin Rohleder, Dominik Schulte and Marco Wilkens contribute to the literature on the performance of actively managed bond funds with their study, Bond Mutual Funds and Complex Investments, which was published in the October 2017 issue of the Journal of Asset Management.
Using a database of nearly 1,000 bond funds, and covering the period 1999 through 2014, the authors analyzed the effects that complex instruments such as derivatives, restricted securities, short selling, leverage and security lending have on the performance and risk characteristics of bond mutual funds.
How the use of complex investments impacts returns is especially important because the authors write that more than 49% of bond funds use derivatives of some kind, compared to only 36% of equity funds.
The difference is even more dramatic for futures, with almost 47% of bond funds using them compared to just 23% of equity funds. In addition, 36% of bond funds use leverage of some kind, 15% through short selling, compared to only 7% of equity funds.
It’s not hard to understand why active bond fund managers would turn to complex instruments – they have to find some way to overcome the burden of their average 0.83% average expense ratio (versus about 0.05-0.25% for the typical passively managed fund). But to what degree are they successful?