Morningstar Magazine - August/September 2018 - 32

Spotlight: Fixed Income

EXHIBIT 1

A further complication arises from fund mortality.
Survival rates in the categories covered by
our study ranged from 39% to 94%, an additional
challenge for investors looking to choose
an active bond fund for the long term. As a result,
the median success ratio, which considers
the effects of fees and fund mergers and
liquidations, ranged from 9% to 49% ( E X H I BI T 2 ).

These 25 fixed-income Morningstar
Categories-15 based in Europe, Africa,
and Asia and 10 in the U.S.-include
5,133 open-end funds.

Category Name
EAA Fund

However, we found that there are large differences
among categories. In our study, we identify
three groups of categories in which gross excess
returns move within a narrow, moderate, and
wide range against the benchmark. As we'll show,
in groups where dispersions were low, and
the median fund tended to perform in line with the
benchmark on a gross basis, the case for lowcost passive investing is strong.

Eaten by Fees The median active bond
manager beat the benchmark in several
categories before fees, but net of
fees, median returns were negative in
all 25 categories.
Net Median

Gross Median

EUR Corporate
EUR Diversiﬁed
EUR Government
EUR High Yield
GBP Corporate
GBP Government

Global
Global Emerging Markets
Global Emerging Markets-Local Currency
Global Emerging Markets Corporate

Our Methodology

Global High Yield

The study includes all open-end funds
in Morningstar's database for the 25 categories.
Liquidated or merged funds that were alive
for at least one three-year period within
the time frame of the study are included.1 Studied
categories are ones in which most funds
use a similar benchmark to measure success. The
data set includes 5,133 open-end funds, with
3,299 funds displaying a return for the most recent
three-year period; others had been merged
or liquidated before the end of October 2017.

USD Corporate

For each category, we identified the most
representative exchange-traded fund available in
our database-that is, the earliest-launched
ETF that tracks the category index or, in cases
where this was not possible, the earliest-launched
ETF that tracks an index with a high overlap
in constituents with the category index.

USD Diversiﬁed
USD Government
USD High Yield
US Fund

Corporate
Emerging Markets-Local Currency
Emerging Markets
High Yield
Inﬂation-Protected
Intermediate-Term
Long-Term
Long Government
Short-Term
Short Government

Source: Morningstar Direct. Data as of 10/31/2017.

3 Net returns of our selected share classes against

We looked at performance through three metrics:

an ETF-that is, an investable version of the
benchmark with fees.

1 Gross return calculations comparing share

classes in each category against their respective
category index.
2 Net returns of our selected share classes
compared against the index of each category.

Factors Other Than Fees

Before diving into our results, it's useful to consider
the factors other than fees that lead fixed-income
funds to trail their benchmarks so often.

-3
-2
Excess Return

-1

0

The first factor is the weight of transaction costs.
In contrast to equity indexes, which
are often rebalanced annually or quarterly, the
majority of bond indexes are rebalanced
monthly to capture new bonds that are issued,
others reaching maturity or being "called,"
and bonds that no longer comply with the index's
inclusion rules. This results in a significant

1 We use rolling three-year periods because they reflect a reasonably long investment horizon. The use of rolling three-year periods also allows for a fairly high number of periods to be analyzed.
(We have also analyzed five-year results, which were directionally similar to three-year numbers, though this yields a smaller sample size.)

32

Morningstar August/September 2018

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Table of Contents for the Digital Edition of Morningstar Magazine - August/September 2018
