Opinions in the active-passive investment debate have drifted poles apart over recent years. We revisit this discussion by contrasting equity and bonds. We look at performance numbers and find that, unlike their stock counterparts, active bond mutual funds have largely outperformed their median passive peers over our sample period. We offer conjectures as to why bonds and stocks differ. Differences may be due to:
- The large proportion of noneconomic bond investors
- Benchmark rebalancing frequency and turnover
- Structural tilts in fixed income space
- The wide range of financial derivatives available to active bond managers
- Security-level credit research and new issue concessions
At a macro level, we believe that a purely passive market would cause severe market risk and resource misallocations. Realistically, neither passive nor active investors can fully dominate at equilibrium. Of course, passive management has its virtues. Yet there is reason to believe that, unchecked, passive management may encourage free riding, adverse selection and moral hazard.