Active vs. Passive: Bond Funds Compared to ETFs

• In a separate post, we examined US equity mutual funds and found they often lag behind the S&P 500 and MSCI World ETFs. But how do bond mutual funds compare?
• We analyzed a vast database of US bond mutual funds, focusing on taxable and municipal bonds with assets over $300 million, excluding closed-end and leveraged/inverse funds. These funds were categorized by Morningstar based on their investment styles.
• To ensure a fair comparison, we selected ETFs that closely matched each bond fund’s investment style, were passively managed, held substantial assets, and had a history of at least 10 years. Only the Intermediate Core-Plus Bond category had an ETF with less than 10 years of history.
• Our analysis revealed nuanced results: while passive ETF indexing generally outperformed actively managed equity mutual funds, actively managed bond funds demonstrated the potential to outperform their passive counterparts in certain categories.

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This outperformance can be attributed to several factors:

• Pricing Inefficiencies: The bond market, with over 14,600 constituents in the S&P US Aggregate Bond Index, is much larger and more complex than the equity market. This complexity creates opportunities for active managers to identify mispriced assets.
• Lower Volatility: Bonds exhibit lower volatility than stocks, providing a more stable investment environment.
• Market Size: With $6.6 trillion in new issues in the US in 2022, the bond market's vastness offers ample opportunities for active managers to exploit mispricings.

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While passive bond ETFs have their advantages, actively managed bond mutual funds and ETFs can be attractive for investors seeking higher returns. However, consistent outperformance over multiple time horizons remains challenging.

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Happy Long-Term Investing from the Quantlake Team!