Fixed income: when should you grab the steering wheel?

Passive bond funds are most suitable for liquid markets, while active or systematic approaches can add value when bond selection, liquidity and default risk matter.

• Passive funds offer broad, transparent and generally lower-cost exposure by tracking an index rather than making active decisions on rates, growth or individual issuers.
• Corporate-bond indices weight issuers by the amount of debt outstanding, so the largest borrowers can receive the greatest weights without this reflecting their relative attractiveness.
• A global investment-grade benchmark can contain more than 18,000 bonds and a global high-yield benchmark more than 3,000, making precise replication difficult and costly.
• Corporate bonds trade over the counter with uneven liquidity, so representative sampling, new issuance, rating changes, maturities and rebalancing can cause passive funds to lag their benchmarks, especially in volatile markets.
• High-yield markets are less liquid and more diverse, and historical evidence indicates that passive high-yield ETFs can underperform their benchmarks while still bearing tracking risk.

Takeaway: Investors should use passive funds for low-cost exposure to liquid markets, consider active management where credit selection and avoiding weak issuers are important, and view systematic strategies as a transparent middle ground rather than assuming that passive and active are the only choices.