Download Active vs. Passive Management in 12 Points

Quantitative Research and Analytics
April 2017
Bonds Are Different:
Active vs. Passive
Management in 12 Points
For institutional investor use only
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Agenda
1/ Does active management work?
2/ How are bonds different?
3/ Other thoughts on active management
4/ Conclusions
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1
Based on the media, who is winning the
active vs. passive debate?
Source: CNBC, The Wall Street Journal, Bloomberg, Market Reporters, US Market Editor
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2
The trend into passive fixed income is accelerating
Quarterly flows in taxable bond funds
Active Flows
120
Passive Flows
Passive Percentage of total assets
30%
100
25%
80
60
20%
40
15%
20
0
10%
-20
5%
-40
0%
-60
Dec '07 Jun '08 Dec '08 Jun '09 Dec '09 Jun '10 Dec '10 Jun '11 Dec '11 Jun '12 Dec '12 Jun '13 Dec '13 Jun '14 Dec '14 Jun '15 Dec '15 Jun '16 Dec '16
As of 31 December 2016; Source: Morningstar Direct
Data limited to US fund flows.
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3
Point 1: Active bond funds and ETFs largely
outperformed their median passive peers
Percentage of active mutual funds and ETFs that outperformed their median passive peers after fees
1-Year
90%
BONDS
3-Year
5-Year
10-Year
EQUITIES
80%
70%
60%
50%
40%
30%
20%
10%
0%
All bond
categories
IntermediateTerm Bond
High Yield
Bond*
Short-Term
Bond*
All equity
categories
Large Growth
Large Blend
Large Value
As of 31 December 2016; Source: Morningstar Direct
* High Yield Bond and Short-term Bond is shown for 7-year trailing period as passive peer 10-year track record is not available.
Past performance is not a guarantee or a reliable indicator of future results. The three largest categories are based on numbers of active mutual funds and ETFs with at least one-year return histories.
Based on Morningstar U.S. ETF and U.S. Open-End Fund categories (institutional shares only). To avoid potential survivorship bias, we included funds and ETFs that were live at the beginning of each
sample period but were liquidated or merged as of 31 December 2016. Chart is provided for illustrative purposes and is not indicative of the past or future performance of any PIMCO product.
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Point 2: Are bonds different?
Outperformance over benchmarks and outperformance over median
passive peers after fees
Percentage of active mutual funds/ETFs outperforming median passive
100%
90%
80%
70%
10-year
60%
3-year
5-year
1-year
50%
5-year
40%
10-year
3-year
30%
1-year
20%
All bond categories
10%
All equity categories
0%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Percentage of active mutual funds/ETFs outperforming benchmark
As of 31 December 2016; Source: Morningstar Direct
Past performance is not a guarantee or a reliable indicator of future results. Based on Morningstar U.S. ETF and U.S. Open-End Fund categories (institutional shares only). To avoid potential
survivorship bias, we included funds and ETFs that were live at the beginning of each sample period but were liquidated or merged as of 31 December 2016. Some categories contain funds with a wide
range of benchmarks. Chart is provided for illustrative purposes and is not indicative of the past or future performance of any PIMCO product.
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Point 3: Active managers should be evaluated over
a long horizon
Number of years needed for the manager to beat the index
with 90% confidence
100%
Years
0.7
3.5
0.5
7
0.3
20
0.2
48
90%
Probability of outperformance
Information ratio
Probability of outperformance in 5 years
80%
70%
60%
50%
0.0
0.1
0.3
0.4
0.6
0.7
0.8
1.0
Information ratio
Source: PIMCO
Hypothetical example for illustrative purposes only. Provided for illustrative purposes and is not indicative of the past or future performance of any PIMCO product.
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Point 4: It is not just about active versus passive
Bond holdings by noneconomic investors
Investor group
Bond holdings ($ trillion)
Investment objective
– Foreign exchange
– Reserves
10.8
Stabilize exchange rates
– Domestic holdings
4.5
Manage money supply
U.S. insurance
4.3
Book yield, predictable income,
regulatory-driven capital charges
U.S. banks
2.8
European insurers
5.3
European banks
4.7
Asian banks and insurers
12.6
Other banks and insurers
2.0 – 3.0
Central banks
Total
47.0 – 48.0
~47% of $102 trillion global
bond market is controlled
by noneconomic investors
Total
bond
holdings
47.0–
48.0
As of 31 December 2016; Source: Company filings, European Federation, EIOPA, EBA, SNL Financial, Bloomberg and PIMCO.
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Point 5: Information is vital to trading and rebalancing
New issuance in U.S. corporate bond market versus U.S. stock market ($ trillions in Q1 2016 – Q4 2016)
Total outstanding
U.S. equity
$25.2
0.78% is new issuance
Total outstanding
U.S. corporate debt
$8.5
17.84% is new issuance
$0
$5
$10
$15
$20
$25
$30
SOURCE: SIFMA, Bloomberg; As of 31 December 2016
Note: Chart shows the extent to which new issuance affects the debt and equity markets U.S. companies access in order to finance themselves. The S&P500, which has a market capitalization of around
$20tn, has a turnover of 4% a year, as company stocks enter and leave the index for reasons other than new issuance. Less than 1% relates to new issuance. Active equity managers are able to trade on the
basis of this, as inclusion in the index can be a tailwind for a firm’s stock price. By contrast, 22.2% of Bloomberg Barclays U.S. Aggregate was new issuance, in the period 31 Dec ’15– 31 Dec ’16.
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Point 6: Off-index and active share matter
A scatter plot of 5-yr excess returns against fund-index return correlations2
Summary statistics for excess fund and factor returns
(January 2007–December 2016)1
Mean
(annualized)
Volatility
(annualized)
Mean ER
0.4%
1.9%
Dur
0.6%
0.8%
IG
0.1%
1.0%
HY
1.0%
2.9%
4%
Correlation
Mean ER
Dur
IG
HY
Mean ER
1.00
-0.52
0.81
0.89
Dur
-0.52
1.00
-0.40
-0.49
IG
0.81
-0.40
1.00
0.87
HY
0.89
-0.49
0.87
1.00
5-year annualized excess return
3%
2%
1%
0%
-1%
-2%
50%
1 Sample
60%
70%
80%
90%
100%
Correlation with benchmark
consists of average monthly excess returns for active mutual funds and ETFs in “Intermediate-Term Bond” Morningstar category, with Bloomberg Barclays US Aggregate Bond Index as their
primary prospectus benchmark and at least 10-year return histories.
2 Sample consists of active U.S. mutual funds (institutional shares only) in “Intermediate-Term Bond” Morningstar category with Bloomberg Barclays US Aggregate Bond Index as their primary
prospectus benchmark.
As of 31 December 2016; Source: Morningstar and Barclays
Duration: Excess returns of Bloomberg Barclays US Treasury Index over cash (1M OIS), per unit of duration. Investment grade: Excess returns of Bloomberg Barclays US Corporate IG Index over durationmatched Treasuries, per unit of spread duration. High yield: Excess returns of Bloomberg Barclays US Corporate HY Index over duration-matched Treasuries, per unit of spread duration.
Past performance is not a guarantee or a reliable indicator of future results. Chart and Table are provided for illustrative purposes and is not indicative of the past or future performance of
any PIMCO product.
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Point 7: Structural tilts are not always beta
What is a
systematic factor?
Why is duration a
systematic factor?
Is timing of systematic
tilts beta or alpha?
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Point 8: A purely passive market would cause severe
market risk and resource misallocations
Source: Getty images
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Point 9: Neither passive nor active investors can
dominate at equilibrium
Source: Grossman, Sanford, and Joseph Stiglitz. “On the Impossibility of Informationally Efficient Markets: Reply.” The American Economic Review, vol. 72, no. 4, 1982, pp. 875–875
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Point 10: Passive management, unchecked, may
encourage free riding, adverse selection and moral hazard
Japan GDP, as percent of developed market GDP*
Japan
9.84%
Japanese government debt, as percent of
all developed market government debt outstanding
Japan
23.29%
As of 31 March 2017.; Source: World Bank, Barclays;
* As of December 2015
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Point 11: Passive management has its virtues
• Helps allocate capital efficiently
• Helps asset-allocation-focused investors
• May overinvest in research
• Helps keep active from overinvesting
Optimal mix depends on the market
More liquid and efficient markets may accommodate fewer active managers
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Point 12: There is no such thing as passive
(just different shades of active)
Is it possible to
replicate the market?
Investors must decide when
to buy and sell passive ETFs.
Is that active management?
What is the role of
asset allocation? Can
that be done passively?
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15
Conclusions
Active management can work in fixed income
Bonds are different
• Non-economic investors
• Benchmark rebalancing and turnover (includes new issue concessions)
• Structural tilts (sometimes expressed with derivatives)
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Appendix
This presentation contains hypothetical analysis. Hypothetical and simulated examples have many inherent limitations and are generally prepared with the benefit of hindsight. There are frequently sharp
differences between simulated results and the actual results. There are numerous factors related to the markets in general or the implementation of any specific investment strategy, which cannot be fully
accounted for in the preparation of simulated results and all of which can adversely affect actual results. No guarantee is being made that the stated results will be achieved.
Management risk is the risk that the investment techniques and risk analyses applied by an active manager will not produce the desired results, and that certain policies or developments may affect the
investment techniques available to active manager in connection with managing the strategy.
Performance results for certain charts and graphs may be limited by date ranges specified on those charts and graphs; different time periods may produce different results. Charts are provided for
illustrative purposes and are not indicative of the past or future performance of any PIMCO product.
All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and
bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally
fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased
price volatility. Bond investments may be worth more or less than the original cost when redeemed. Derivatives may involve certain costs and risks, such as liquidity, interest rate, market, credit,
management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested.
There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially
during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision.
The correlation of various indexes or securities against one another or against inflation is based upon data over a certain time period. These correlations may vary substantially in the future or over
different time periods that can result in greater volatility. It is not possible to invest directly in an unmanaged index.
This material contains the current opinions of the manager and such opinions are subject to change without notice. This material is distributed for informational purposes only and should not be
considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but
not guaranteed.
PIMCO provides services only to qualified institutions and investors. This is not an offer to any person in any jurisdiction where unlawful or unauthorized. | Pacific Investment Management Company
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Appendix
maximum amounts and calculation methodologies of each type of fee and expense and their total amounts will vary depending on the investment strategy, the status of investment performance, period
of management and outstanding balance of assets and thus such fees and expenses cannot be set forth herein. | PIMCO Canada Corp. (199 Bay Street, Suite 2050, Commerce Court Station, P.O. Box 363,
Toronto, ON, M5L 1G2) services and products may only be available in certain provinces or territories of Canada and only through dealers authorized for that purpose. | PIMCO Latin America Edifício
Internacional Rio Praia do Flamengo, 154 1o andar, Rio de Janeiro – RJ Brasil 22210-906. | No part of this publication may be reproduced in any form, or referred to in any other publication, without
express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. ©2017, PIMCO.
CMR2017-0426-265343
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