Sources of Excess Return and Implications for Active Fixed-Income Portfolio Construction

The continued development of indexes, factor frameworks, and attribution tools in fixed-income markets provides a deeper understanding of manager performance and optimal portfolio construction techniques. In this article, the authors use quarterly holdings data for a broad sample of fixed-income mutual funds to attribute active returns to (1) the returns to static factor exposures, such as a structural tilt to credit spreads; (2) time-varying factor exposures, such as varying duration over the cycle; and (3) individual bond security selection. They find that, although bond funds in aggregate demonstrated positive alpha, a nontrivial amount of their performance was driven by exposure to static factors as opposed to dynamic timing or security selection. The authors illustrate how active portfolio managers can employ index products to more efficiently express factor views and help capture more excess return through reduced costs and frictions.