Article from About.com
Conventional wisdom says
that actively managed mutual funds are better for bond
investing than passively managed (index) funds. Is this so-called
wisdom best for you to follow? How have actively managed bond funds
compared to passively managed (index) bond funds lately?
Actively Managed vs
Index Bond Funds
The reasoning for the
conventional wisdom that actively managed funds beat index fundswhen it comes to bond
investing is that a manager can navigate the complex fixed income markets by anticipating
changes in interest rates. Therefore the actively managed fund manager
may make advantageous moves accordingly and outperform the passively managed
(index) bond funds. Or so the story goes...
The Basics on Bonds
Bond prices tend to move in opposite direction of interest
rates. The movement in price is more pronounced with the longer duration
bonds. For example, if interest rates are rising, your long-term bond
funds will typically lose more value than your intermediate and short-term bond
funds. Who wants to hold the old bonds that pay lower rates of interest
when the newer ones pay higher interest?
If you have an bond index fund and the economy is headed into a
rising interest rate environment, it's kind of like sitting in a raft headed
toward a waterfall--the raft being the rising interest rates and the water fall
being the falling prices that follow. However, as conventional wisdom
would have it, a manager for an actively managed bond fund could anticipate the
rising interest rates and shift the holdings to shorter term bonds and avoid
much of the price declines (saving you from the worst of the price declines and
keeping you from going over the waterfall).
The Best Bond Fund
Manager vs Index Funds
I just finished
quarterly investment reviews for my clients and noticed that the bond index
funds have been performing much better than than the actively managed bond
funds over the past year. Even one of the greatest bond fund managers in
the world, Bill Gross, has failed to beat the major bond market indexes.
For example, over the past year (as of 9/30/2011) Bill Gross' Harbor Bond Fund Adm (HABDX) is up just 0.20% through the third
quarter, whereas the Barcap Aggregate Bond Index is up 5.26%.
Bill Gross has been saying for months that the best years for
bonds are behind us and an inflationary period with rising interest rates is
ahead of us. His logic is good but financial markets are not often
logical. Interest rates are about as low as they can get but if investors
are fearful, they'll keep putting their money into areas where they perceive
safety, such as bonds, cash or gold.
The lesson learned here
is that even the smartest mutual fund managers can't predict the future.
As a bond fund investor, you have a choice between picking a manager (actively
managed) or picking the market (passive-index). Your best bet may be on
the latter.