As the worst three-year rout on record starts fading from view, some of the biggest managers of bond funds still have a daunting task: winning back clients who fled with hundreds of billions of dollars.
Record sums — now nearly $6 trillion — are sitting in money-market funds held by investors who sought refuge from falling bond prices and this year’s turmoil at US banks. With rate cuts looking more likely next year, a bond market rally that began last month has become supercharged, and some of that cash theoretically should be headed to funds run by the brightest managers.
The trouble is that fixed-income investors are increasingly favoring the same type of low-cost index portfolios run by Vanguard Group Inc., State Street Corp. and BlackRock Inc. that swept through the ranks of actively managed stock funds over the last decade. Whether active managers can capture more of the flow will decide which ones will flourish or struggle in an industry already enmeshed in price wars and consolidation.
“We are in a winner-takes-a lot moment,” said Rich Kushel, the head of BlackRock’s portfolio management group. “If you’re truly adding real alpha, there will always be a place for you in this industry. For the folks who haven’t, you might as well buy AGG,” he said, referring to the benchmark bond index.
There are glimmers of hope. Active bond managers just reaped their biggest monthly returns since the mid-1980s, and some are seeing a much-needed pickup in flows. The rally in bonds only intensified this past week after the Federal Reserve signaled more potential for interest-rate cuts in 2024, a dovish policy shift that if sustained will bring stability and capital gains for bond funds.
The improved outlook, which also helped equity markets, sent shares for some of the biggest public asset managers surging. BlackRock, Franklin Resources Inc. and Invesco Ltd. are all up at least 30% since late October.
The tumbling yields in turn have rescued the performance of fixed-income funds, providing some solace after a harsh and humbling period of losses and redemptions.
Between the start of 2022 and end of November, actively managed fixed income US mutual funds and ETFs had $547 billion in net outflows, according to Morningstar Inc. Prominent funds at Pacific Investment Management Co., DoubleLine, TCW Group and Franklin’s Western Asset Management have been among those hard hit.
By contrast, investors added a net $410 billion to passive bond funds. The index giants benefited most, with retail and institutional traders alike choosing ETFs and benchmark indexing. BlackRock alone took in $66 billion net to its non-ETF index funds worldwide between the start of last year and the end of the third quarter. About $204 billion in net flows went into its fixed-income ETFs.
More broadly, the sector’s results have been downbeat. Fixed-income revenues dropped about 15% from 2021 to 2022 for the median asset manager and overall, assets declined a median 17%, according to Deloitte’s Casey Quirk consultancy.
More pressure is coming as indexers expand beyond sovereign and investment-grade corporate debt to markets where the fine print in bonds is more nuanced, which gives active managers an advantage. State Street’s emerging-market debt book, for example, was about $6 billion in December 2015; it was about $38 billion in September, said Matthew Steinaway, chief investment officer for global fixed-income, currency and cash.
“The large institutional managers are pivoting toward using indexing as a core,” Steinaway said in an interview.
Past performance will likely determine where the money flows next. On that score, the recent three-year metrics aren’t great. Only 56% of the 552 fixed-income funds and ETFs with at least $1 billion in assets tracked by Morningstar beat their primary benchmark as of Nov. 30. Core US bond funds collectively lost ground, down about 4.4% on annualized basis, slightly better than the Bloomberg Agg index’s 4.5% decline.