The fixed income sector is undergoing a seismic shift, echoing changes seen in equity markets over the past two decades. As new fund managers and innovative products emerge, traditional actively managed mutual funds are losing their dominance. This transformation is creating a barbell effect, where investors are increasingly favoring cheaper passive vehicles and alternative assets, leaving mid-tier funds struggling to adapt.
Discover the Future of Fixed Income Investing: Embrace Innovation or Face Obsolescence
Emerging Trends in Fund Management
The bond market is witnessing a paradigm shift as novel fund management strategies take center stage. A decade ago, names like Bill Gross and Jeffrey Gundlach were synonymous with fixed income investing. Today, the landscape has evolved dramatically. New entrants in the mutual fund space range from cost-effective passive vehicles that mirror market indices to more complex products engaging in diverse credit exposures. This mirrors the equity market's trajectory, where cheap index-tracking funds and alternative assets like private equity have gained prominence.Investors now favor a barbell investment strategy, which involves allocating capital to low-cost passive funds at one end and higher-risk alternative investments at the other. Traditional actively managed mutual funds, positioned in the middle of this spectrum, have seen a significant decline in market share. Huw van Steenis, vice-chair of Oliver Wyman, highlights that this trend is not just a fleeting phenomenon but a structural change in how investors approach fixed income.Data Validates the Shift
The data corroborates this shift. According to Morningstar, a decade ago, four out of six of the world's largest bond funds were actively managed mutual funds. Today, only one remains in the top six, dominated by passive mutual and exchange-traded funds (ETFs). Traditional actively managed mutual funds now account for just 57% of combined fixed-income assets, down from 74% seven years ago.Active ETFs have been gaining traction, driven by lower fees averaging 0.4%, compared to 0.65% for active mutual funds. Larry Fink, CEO of BlackRock, noted this trend last year, stating that the barbell effect observed in equities is now manifesting in the bond market. BlackRock's acquisitions of Global Infrastructure Partners and HPS Investment Partners underscore its strategic move into private infrastructure and credit management, building on its leadership in cheap ETFs across various asset classes.Alternative Managers Thrive Amidst Change
Amidst this transformation, alternative managers are thriving. Six large alternative managers—Brookfield, Carlyle, Ares, Blackstone, KKR, and Apollo—reported net new money growth ranging from 15% to 40% in their credit strategies over the past year. This contrasts sharply with the modest 1% growth of global long-only bond funds. Van Steenis points to a "Cambrian explosion" of hybrid products, such as KKR and Capital International's public-private fund and SSGA and Apollo's planned ETF combining these exposures.Kenneth Lamont, principal of research at Morningstar, agrees that the barbell effect is taking hold, noting a convergence of public and private assets. He attributes this shift partly to the higher fees charged for accessing less liquid credit exposures, making private market business more profitable. However, Lamont cautions that the bifurcation seen in equities may not neatly apply to fixed income due to differences in market structure and investor preferences.Challenges for Passive Bond Funds
Passive bond funds face unique challenges that set them apart from their equity counterparts. Unlike equities, where cap-weighted indices invest more in larger companies, fixed income indices expose investors to the most indebted companies, which may not be desirable. Additionally, the vast number of instruments in many bond indices means fund managers often use stratified sampling to mimic performance, introducing elements of active management.Despite these challenges, active bond fund managers have a slightly better record of outperforming benchmarks compared to equity managers. In Europe, about half of actively managed bond funds have outperformed passive equivalents over one and three years, and a third over five years. This contrasts with equity managers, where only a third outperform over one year, and even fewer over longer periods.Future Outlook: The Rise of ETFs
Van Steenis acknowledges that while it's easier to outperform fixed income benchmarks by adding illiquid bonds, this hasn't saved the majority of active mutual fund managers. Instead, investors are flocking to ETFs, which offer affordability, convenience, and tax efficiency in the US. This trend shows no signs of reversing, signaling a new era in fixed income investing where innovation and adaptation will be key to survival.
