Why passive bond investing falls short, and what advisers can do about it

This article was produced in partnership with Dynamic Funds.

More than ever, advisers are tasked with navigating the uncertainties and complexities of the investment landscape to help clients achieve their financial goals. When it comes to fixed income investing, advisers know that passive strategies just won’t do. 

Active versus passive fixed income investing

In a recent On the Money podcast, Dynamic Funds spoke with Professor Martijn Cremers’, Dean of Notre Dame’s Mendoza College of Business. His groundbreaking research report - Indexing and Active Fund Management: International Evidence explains the pitfalls of passive bond investing.

Passive bond funds aim to do two things: closely track their benchmark - at a low cost. However, according to Cremers, that can be a challenge. The most common bond benchmark, the Bloomberg U.S. Aggregate Bond Index, contains bond securities that are not very liquid and are therefore, difficult or costly to trade.

Cremers contends that more than half the securities in a typical passive bond fund are actually different from its benchmark; hence he coins passive bond fund management an oxymoron.

Actively managed bond funds typically do better than the passive bond funds

While many fund managers claim to be active, the reality is that many are actually “closet indexers” - charging fees for active management while passively mirroring an index. Unlike closet indexers and passive fund managers, Dynamic’s newest Core Fixed Income Team solutions, Dynamic Active Bond ETF (DXBB) and Dynamic Active Corporate Bond ETF (DXCB), leverage five key alpha drivers to increase opportunities and minimize risk.

The Power of 5

While most bond mangers focus on asset allocation and credit allocation, Dynamic’s Core Fixed Income Team also applies rates, currency and derivative strategies to improve performance:

1. Credit management

Our portfolio managers apply well-honed strategies for the active selection of individual credits based on ongoing assessments of corporate fundamentals, technicals and valuations. We actively monitor industry trends, relative value strategies or new issue concessions to manage risk and enhance returns.

2. Asset allocation

Our team makes asset allocation decisions based on geography, sector, asset type, credit rating and term. Unlike an index which is hamstrung to stay within certain asset classes, our asset allocation decisions are based on identifying opportunities while staying away from risks.

Note: Indices are not managed, and it is not possible to invest directly in an index.

3. Rates management

Active management of duration exposure within the portfolios and tactical yield curve positioning allows the team to manage duration risk. This includes yield curve management, duration hedging and Canada/U.S. relative value strategies.

4. Currency management

With the ability to add U.S. exposure in these two ETFs, we can take advantage of opportunities outside of Canada. We add calculated currency exposure when secular opportunities present themselves, with the ability to mitigate the impact of currency fluctuations.

5. Derivatives

Derivatives are utilized for both risk management (interest rate and credit hedging) and income generation, which includes the use of option-writing strategies.

Understanding the Legitimately Active Management® advantage – and the Power of 5, can make the difference to your clients’ financial goals. Visit us at dynamic.ca/corefixedincome to learn more.

Source: Indexing and Active Fund Management: International Evidence*. Martin Cremers et al.; January 2015.

This document has been prepared by Scotia Global Asset Management and is provided for information purposes only.

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