WSJ’s Zweig: Actively Managed Bond Funds Due to Head Back to Earth

Monday, 15 Apr 2013 08:23 AM

By Dan Weil

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Actively managed bond funds have been on fire over the past year, as investors have flocked to them.

But that performance is unlikely to continue, as the funds are increasing their duration risk and buying bonds of lower quality, says Wall Street Journal columnist Jason Zweig.

“As a whole, then, active bond-fund managers are taking extra risks that haven't blown up — yet,” he writes.

Editor's Note:
Economist Unapologetically Calls Out Bernanke, Obama for Mishandling Economy. See What They Did

In the last 12 months, intermediate bond funds have outperformed their benchmark indices by an average of 1.8 percentage points, according to Morningstar research. For long-term government bond funds, the outperformance totals 2.5 points.

Meanwhile, investors have placed a whopping $230 billion into actively managed bond funds, compared with only $63 billion into bond index funds.

As for duration, it measures a fund's sensitivity to interest rate changes. A higher duration means a fund will fall further in times of rising rates.

And the average duration of actively run intermediate bond funds has increased to 4.8 years from 4.4 years since the first half of 2009, according to Morningstar.

“Active bond funds are taking more interest rate risk than they were four years ago — buying longer-term bonds that provide higher yield now, but will lose more money when rates finally rise,” Zweig notes.

In addition, credit quality over the same period of time has fallen for intermediate bond funds — to an average rating of triple-B, the second lowest investment-grade rating, from single-A, or excellent.

Meanwhile, many experts say the Federal Reserve’s quantitative easing will continue to support the bond market.

“As long as the big boys on the block are buying, it’s going to be hard for asset prices to go down,” Jay Mueller, a bond fund manager at Wells Fargo Capital Management, tells Bloomberg.

“We are in unchartered territory. When data worsens, all assets rally because it just means the Fed will stay the course, and that means stocks and bonds can rally.”

Editor's Note: Economist Unapologetically Calls Out Bernanke, Obama for Mishandling Economy. See What They Did

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