Morningstar Magazine - August/September 2018 - 34

Spotlight: Fixed Income

EXHIBIT 4

categories has a lower duration than
the corresponding category index. Many fund
managers-especially those with a cautious
mandate or whose mandate includes
capital protection-have sought to protect their
portfolio from a sudden rise in interest rates,
leading them to miss a large part of
the performance of the index that has been
driven by a broad decline in core government
bond yields.
Despite these challenges, active fund managers
have a wide set of tools at their disposal
to add value against the benchmark. Managers
can tactically adjust risk exposures in their
portfolios, particularly thanks to the growing
availability of derivative products such
as futures and credit default swaps. They can also
add value through security selection and,
in many cases, off-benchmark exposures. Indeed,
there are several categories where the median
active manager has been able to beat the
category index on a gross-of-fees basis, though
the margin of outperformance has often
been slimmer in the recent low-yield environment
and, thus, more likely to be eaten up by fees.
Our Headline Results

We first look across medians of three-year rolling
period gross excess returns in the 25
categories included in the study. We perform this
analysis by calculating the median of funds'
gross excess returns and then examining
the median across categories. We find that the
average category had a slightly negative
gross excess median return of 0.07% annualized
against the category index over the entire
period 2002-17.
However, categories differed starkly in their
profiles, both cross-sectionally and analyzed
through time. E X H I B I T 3 displays the range within
which the category median gross excess
returns have moved through time in three-year
periods. The box plot summarizes the
distribution of three-year gross excess return
median observations between the 25th
and 75th percentiles of the distribution in each
category since January 2002. The dots
represent the lowest and highest median in
each category for the time period.

34

Morningstar August/September 2018

For the study, we chose categories
in which most funds use a
similar benchmark to measure success.

Category Name
EAA Fund

Cream of the Crop In most categories,
funds in the highest quintile have
been able to outperform the category
index over time.
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
Global High Yield
USD Corporate
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.

-1
0
1
Excess Return for Funds in the 20th Percentile

It is apparent that in some categories the median
was consistently close to zero and moved
only in a tight range. These categories
were typically driven by the gravitational pull of
the index representing their target universe.
In Europe, Asia, and Africa, or EAA, categories
such as EUR corporate bond, EUR diversified
bond, EUR government bond, GBP government
bond, USD diversified bond, and USD government
bond, as well as US fund categories such as
inflation-protected bond and short government,
investors can forecast gross excess returns
of the typical fund with a fairly high confidence.

In contrast, in categories such as EAA fund global
emerging-markets corporate bond, the median
moved in an exponentially wider range around the
benchmark index, which does not allow
any meaningful forecast of typical excess returns
to be made.

2

In 13 of our 25 categories, median gross excess
returns were positive more often than
not in the three-year periods analyzed. The highest
median was within US fund corporate bond,
where the median manager delivered a 0.76%
annualized gross excess return over three-year
Table of Contents for the Digital Edition of Morningstar Magazine - August/September 2018
