(Bloomberg) -- 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.
Read more: Biggest Boom in Bonds Since 1980s Sparks Everything Rally
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.
Managers Whiff
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.
“If a specific active manager does poorly, underperforms their index, and is in the bottom quartile of peers, these allocators do take another look at that and say, ‘is this what we want for our strategy?’ ” said Paul Olmsted, a Morningstar analyst. “Did the manager make good decisions? Did they make bad decisions?”
Active managers say they won’t succumb to the same vicious cycle that hurt and sometimes eliminated their counterparts in equities. BlackRock, for one, has netted nearly $91 billion of new cash to its active fixed-income funds from the start of 2022 through the end of the third quarter.
“We just have to put up good returns,” said Dan Ivascyn, the 54-year-old chief investment officer of Pacific Investment Management Co. Now is the time for active managers to prove their worth, he said during a November interview in his Newport Beach, California office. “If you generate value versus passive alternatives, flows are going to come in.”
Read more: Bond Managers of $2.5 Trillion Make Case for Ditching Cash
Ivascyn’s $132 billion Pimco Income Fund, which he has helmed since inception in 2007, posted an 8.6% return this year through Dec. 14, among the industry’s best.
Firms are developing new investment strategies using technologies, including artificial intelligence, to find factors driving markets that can beat the benchmarks, according to Andrea DiCenso, who oversees bond portfolios at active-manager Loomis, Sayles & Co.
“The case for passive in my mind is not a very strong one in fixed income,” George Walker, chief executive officer of Neuberger Berman, said in an interview. “Passive has outperformed in certain parts of the U.S. large-cap equity markets, but I think over time people will become more discerning on the best use.”
Neuberger Berman had $167 billion in actively managed public fixed-income investments at the end of September and had net inflows of about $2 billion in the third quarter, according to the company.
Bonus Impact
Western Asset has benefited from the recent rebound in fixed income, with its Core Plus bond fund rising 6.2% in the past month through Dec. 14. That’s good enough to push it back into positive territory for the year and beat almost all its peers for performance, ranking in the 99th percentile.
“We had a poor call in 2022 on inflation and the Fed for sure, but it isn’t as if we’re broken or a different firm,” said Mark Lindbloom, a Western Asset portfolio manager. He’s expecting to keep clients and see more inflows. “We’re starting to see those inquiries pick up quite a bit,” he said.
Those inflows matter a lot to the financial fortunes of not only clients but also the money managers themselves and their publicly traded firms. Bonuses have been cut, and at the bottom quartile of firms, managers saw a 20% decline in overall compensation in 2022 from 2021, according to Casey Quirk.
“If an asset manager doesn’t deliver robust inflows this quarter, it will be disappointing and likely reverse most of the recent gains that asset manager share prices have experienced,” said Kyle Sanders, senior research analyst at Edward Jones.