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S&P Capital IQ


08/25/16 05:00:35 PM


Some investors think active management is more valuable for fixed income than for equities.. However, recent research from S&P Dow Jones Indices (SPDJI) serves as a reminder that past performance is not necessarily an indicative of future results, even for fixed income. (See "Consistently Strong Equity Fund Performance Hard To Find," published yesterday on the Trends & Ideas tab in MarketScope Advisor, for a take on equity fund performance persistence.)

In its semi-annual performance persistence scorecard, SPDJI looked beyond active U.S. equity mutual funds' ability to maintain a top half performance ranking in one 12-month period for two additional 12-month periods and included various fixed income styles.

The data is relatively discouraging for actively managed long-term investment grade (16%), intermediate-term investment-grade (17%) and high yield (25%) funds and their ability to duplicate success. However, the numbers are more encouraging for the persistence of those strong performing active emerging market debt (46%) and short-term investment-grade (37%) funds.

Year to date through August 10, fixed income ETFs gathered an estimated $62 billion of assets in contrast to $91 billion of net new money for fixed income mutual funds, according to ICI data.

S&P Global Market Intelligence thinks the SPDJI research makes the case for certain ETFs even more compelling. Actively managed mutual funds tend to be much more expensive than passive ETF alternatives and the higher cost, combined with often elevated credit risks, tends to limit a mutual fund's ability to maintain its performance success.

For example, in 2013, Franklin High Income Fund (FHAIX 2 ***) rose 7.64%, ahead of the 6.85% Lipper high yield peer average. However, the fund lost 0.39% in 2014 and 10.74% in 2015, lagging peers by 175 and 667 basis points, respectively.

Peer Pioneer High Yield Fund (TAHYX 9 ***) was an even stronger performer in 2013, climbing 12.31%. However, in the next two years the fund lost 0.15% and 4.89%, trailing its peer group as well as leading high yield ETFs.

iShares iBoxx High Yield Corporate Bond ETF (HYG 86 Overweight) rose 5.76% in 2013, less than the 6.85% mutual fund average. But, passively managed HYG's 1.91% gain in 2014 and 5.01% loss in 2015 were better than the 1.36% and 4.07% respective positive and negative returns for active funds. HYG has $17 billion in assets.

A smaller, alternatively weighted PowerShares Fundamental High Yield Corporate Bond Portfolio (PHB 19 Overweight) rose 4.40% and 2.34% in 2013 and 2014, before falling 3.04% in 2015.

Both ETFs have a 0.50% expense ratio, much lower than the 1.09% for the Lipper high yield mutual fund peer group. While we don't think investors should make fund decisions based solely on past performance success, only 42% outperformed HYG's 4.17% three-year annualized total return through August 17 and only 16% were ahead of PHB's 5.02%.

At the end of July, HYG had approximately 50% of assets in bonds rated BB or equivalent from ratings agencies, including S&P Global Ratings, with 8% in bonds rated below B. Meanwhile, PHB had 55% in BB-rated bonds and 0% in bonds rated lower than B.

The index PHB tracks focuses on an issuer's book value, gross dividends, gross sales, and cash flow. However, only bonds rated between B- and BB+ (or equivalent) can be included. Such credit controls limits PHB's 30-day SEC yield to 4.2%, below HYG's 5.7%.

In contrast, high yield bond mutual funds recently had on average approximately 35% in BB-rated bonds and 10% in bonds rated below B, average credit metric similar to the exposure provided by SPDR Barclays High Yield ETF (JNK 36 Overweighht). In addition, aided by analytical teams that conduct proprietary credit research, active mutual funds are more likely to hold a large percentage of assets in non-rated bonds, limiting investors' ability to understand the credit risks.

TAHYX had 27% of assets in non-rated bonds, while FHAIX had 4.9% in such securities.

FHAIX, up 14.6% year to date through August 17, was one of the 277 mutual funds (42% of the peer group) to outperform HYG's 11.02%. However, we caution investors of making much of such a short period of outperformance because, as the SPDJI data suggests, it can be fleeting.

Other high yield mutual funds funds that are outperforming in 2016 and had similar relative success in 2015 include Lord Abbett High Yield Fund (LHYAX 7 ****) and Prudential High Yield Fund (PBHAX 5 ****).

S&P Global Market Intelligence operates independently from S&P Global Ratings and SPDJI.


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