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Does active beat passive for global bonds? We have the numbers

Does active beat passive for global bonds? We have the numbers

by Robert St George Sep 12, 2017 at 11:20

 

The constituents of global bond indices should worry investors and excite those marketing active funds.

The Bloomberg Barclays Global Aggregate index, for example, has a 40% weighting to the US, where serving the national debt is a political bargaining chip. The index’s next three largest allocations are to Japan, Germany and France, where yields on government bonds of less than five years are negative.

You get the picture; equities indices feature the largest companies (think Apple which is more than 2% of the 1,170-strong MSCI World Index) while bond yardsticks are bloated by the biggest debtors.

This appears not to bother fund buyers, however. Over the past year a net £8.6 billion has gone into global bond ETFs worldwide, according to data provider TrackInsight.

Flows into actively managed global bond funds in the UK have been positive too, with the sector attracting a net £2.3 billion over the past year, but active managers must be wondering why they aren’t taking much more of the money being allocated to the sector.

Poorly served

Part of the reason is inevitably their performance. Over the past three years, the average active global bond manager has failed to deliver positive risk-adjusted returns. The manager information ratio, a measure of the returns they are able to deliver over the benchmark for the risk they take on, is negative across the sector, with a ratio of -0.184 on an equal weighted basis.

A reading of 1 would indicate an active manager had delivered one unit of outperformance for every unit of active risk taken on, while a reading of -1 would show one unit of underperformance for each unit of risk.

Moreover, the average investor in the sector has undershot even that: the funds with negative risk-adjusted returns for the period represent 57% of the global bond category by market share; in this sub-segment the average information ratio has been -0.44 over the past three years.

Active global bond managers look a lot better over the past year, with an average information ratio of 0.99 indicating that they have comfortably beaten the index. The damage may nevertheless have already been done to active managers’ reputation here.

So for those who do take the passive route in global bonds, what are the options?

The cheapest and broadest vehicles are tracker funds, with Vanguard’s Global Bond Index available for 0.15% – albeit with a 0.2% initial charge – and the narrower iShares Overseas Government Bond Index for 0.11%.

On the ETF side, the cheapest London-listed equivalent is the dollar denominated iShares Global Government Bond Ucits ETF (IGLO) with ongoing charges of 0.2%.

Deutsche Bank’s db x-trackers Global Government Bond Ucits ETF (XG7S) has the same fee but only for the unhedged version - currency-hedged varieties come in at 0.25%. 

Deutsche also has the db x-trackers Barclays Global Aggregate Bond Ucits ETF (XBGG) with a 0.3% fee reflecting a far broader portfolio that includes corporate debt.

A smarter choice 

For a smarter beta alternative, one of the few global bond products is the ETFS Lombard Odier Global Government Bond Fundamental GO Ucits ETF (CORG).

Rather than weighting its index by the amount of debt issued by a country, this Lombard Odier methodology allocates according to a combination of an issuer’s current indebtedness, its revenues and its social and political stability. It is thus more active even than those weighted by issuers’ GDP, for instance, and is also rebalanced on a monthly basis.

This process inevitably results in a very different portfolio: the US drops down to a 12% weight, with the likes of the Czech Republic, Korea, and Mexico also moving above the UK.

The characteristics of the underlying bonds differ more subtly from traditional indices: the average coupon in the Lombard Odier ETF is 3.49% and the average maturity 8.41 years, compared with equivalent figures of 2.5% and 8.6 years for the Vanguard Global Bond Index.

The emphasis on the fundamentals seems to have been rewarded, with the Lombard Odier ETF up by 12% so far this year while the broader Vanguard index has gained only 2.1%. Despite this, the ETF has a relatively modest total expense ratio of 0.25%.

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