Active investment management can help investors achieve their long-term financial goals while navigating market volatility, asset dislocations, and managing risk.
A Compelling Case for Active in Fixed Income
Unlike equity indices, fixed income benchmarks have inherent flaws that make passive replication a risky undertaking. One key issue lies in the construction of bond indices, as the more debt a company or country issues, the larger its representation is within an index. This means that passive investors tracking the index are effectively increasing their exposure to the biggest borrowers, regardless of their creditworthiness or financial stability. This approach is inherently flawed, as it rewards indebtedness rather than sound financial management.
The U.S. Aggregate Bond Index (Agg) tracks over $50 trillion of assets and is often seen as the benchmark for fixed income. The index is difficult to replicate due to the sheer number of individual securities it holds (around 10,000 individual bonds). The index includes government Treasury securities, corporate bonds, mortgage-backed securities, asset-backed securities, and municipal bonds that are of investment-grade quality or better (at least BBB-rated).
U.S. Aggregate Bond Index Sector Breakdown
Source: Bloomberg, as of 30 June 2025.
Conversely, active fixed income managers have the flexibility to navigate these challenges. They can conduct in-depth credit analysis, assess the financial health of borrowers, and make informed decisions about which bonds to include in their portfolios. This allows them to avoid overexposure to highly indebted entities and potentially mitigate risk.
Active managers can capitalize on opportunities outside of traditional bond indices. The Agg omits significant portions of the fixed income universe, such as high-yield bonds, non-agency mortgages, and certain commercial mortgage-backed securities. This means that active managers can potentially enhance returns and diversify their portfolios by evaluating securities beyond the confines of the index.
Yields Are Above Long-Term Averages
Source: Bloomberg, as of 30 June 2025. *Municipal yields are tax-adjusted. Assumes top marginal Federal bracket of 37% and Medicare surcharge of 3.8%.
The ability to adjust a portfolio’s interest rate sensitivity, or duration, is another key advantage of active management in fixed income. The Agg’s duration has increased over time, making it more sensitive to changes in interest rates. Active managers can proactively manage duration to protect portfolios from rising rates or to capitalize on falling rates.
A Differentiated Approach to Equities
While the case for active management may be strong in fixed income, it is also quite relevant in equity markets, especially in international equity markets. Information may be less readily available, and accounting standards may differ in international equity markets, where active managers with local expertise can gain a significant edge. They can conduct on-the-ground due diligence, assess local market dynamics, and make informed investment decisions that passive strategies may miss.
In addition, correlations between markets may be returning to more normal levels. This suggests that diversification through international equities may provide meaningful benefits, and active managers can play a crucial role in selecting the optimal international stocks to enhance portfolio diversification.
Sector Breakdown: U.S. vs. Non-U.S.
Source: S&P Dow Jones Indices and MSCI, as of 31 July 2025.
Active management is an indispensable approach for navigating periods of market volatility and economic uncertainty. Investment managers can use their expertise to identify undervalued assets, manage liquidity, and adjust portfolio positioning to mitigate potential downturns in times of recession or market stress. Active equity managers can employ bottom-up fundamental research to identify companies with strong growth potential, attractive valuations, and sustainable competitive advantages.
The Importance of a Long-Term Perspective
We can’t emphasize enough the importance of a long-term perspective in investing. We would also caution against trying to time the market or making short-term decisions based on either fear or greed. Instead, we would advocate for a disciplined approach that focuses on long-term fundamentals and sustainable growth.
Active management, when executed effectively, aligns well with this long-term perspective. Active managers conduct in-depth research, analyze company fundamentals, and make investment decisions based on a multi-year outlook. This contrasts with passive strategies that track an index, regardless of its underlying composition or long-term prospects.
Key Takeaways
While passive investing has its merits, active management remains a crucial tool for investors seeking to navigate the complexities of today’s markets. By employing skilled active managers, investors can potentially enhance returns, manage risk, and achieve their long-term financial goals. The key lies in selecting managers with a proven track record, a disciplined investment process, and a deep understanding of the markets in which they operate.
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