Even before bond yields ripped through the roof this month, some asset managers had begun quietly shifting strategies in a fundamental way: less index, more brain.
Instead of delving deeper into matching benchmarks that are now loaded with negative-yielding debt, they're returning to more traditional methods of picking according to fundamentals. That means looking for governments narrowing deficits or company turnarounds.
While the sell-off shook markets and drove up yields from New York to Zurich, 28 per cent of the investment grade securities in the $45-trillion Bloomberg Barclays Global Aggregate Index still earn less than 1 per cent.
That's been driving investors including J.P. Morgan Asset Management to increasingly buy lower-rated debt to avoid holding securities such as the AAA Dutch five-year bond yielding minus 0.25 per cent -- just because it's in an index they're measured by.
"It's a little revolution within bond management," said Nick Gartside, chief investment officer at the JPMorgan Chase & Co. unit, which controls $1.7-trillion globally. "You've got to look at what's in the benchmark, and that German bond with minus 10 basis points may not be good value. It's going to be tricky going forward in terms of making money if you're married to a benchmark. Bond managers have got to be a bit more active."
That brings more risk and volatility: The Bloomberg Emerging Market Composite Bond Index was among the biggest losers in the week after the U.S. election, dropping 3.5 per cent.
It's too early to tell if actively managed funds can reverse the trend of losing market share to passive "tracker" investments that typically pay managers lower fees. Passive funds, popularized in the early 1990s, gained more strength after the 2008 financial crisis.
This year, however, a net $219-billion was added to actively managed fixed-income funds in the first nine months of this year, Morningstar Inc. data show. That beat the $161-billion that flowed into their passive competitors. It's a reversal from 2015, when actively managed products had a $1.2-billion outflow.
Mauro Ratto, who co-manages the €2.5-billion Euro Strategic Bond fund at Pioneer Asset Management SA, said he branched out from European corporate debt and into emerging markets, including an Argentinian bank and Russian energy companies. More than 40 per cent of the euro-denominated fund is now allocated to these markets, compared with 20 per cent in 2013. The manager has also added loans and distressed debt to the portfolio -- an absolute no-go just a few years ago.
"The very low level of rates worldwide pushed us to an look for an alternative, and the only way to do this is to understand where the value is, and where you are paid a decent enough risk premium," said Mr. Ratto, whose fund's minus 0.01-per-cent return in the past month beat 95 per cent of rivals in his asset class, according to data compiled by Bloomberg. "We are definitely more active now."
Exposure to China
The Dublin-based asset manager is also using alternative strategies to build portfolios to attract investors shunning benchmarks. Last year, it launched a fund that allocates money to government bond markets based on the size of their economies, instead of their amount of debt -- the so-called market-cap approach traditionally adopted in indexes. This means giving less emphasis to U.S., Japan and Europe while having a high exposure to China.
Salman Ahmed, the London-based chief strategist at Lombard Odier Asset Management (Europe) Ltd., which oversees about $160 billion in assets, has also been buying debt that's not found in traditional benchmarks, such as Chinese and Indian sovereign bonds.
"We have to take more risks but we have to do it prudently, treating each country on its own merit," Mr. Ahmed said. "A market-cap approach is not going to work because it doesn't care about quality."