Active bond funds outperformed their passive peers in 2023, Morningstar says. These are top performers

Published Wed, Mar 20 20241:12 PM EDTUpdated Wed, Mar 20 20241:58 PM EDT

Investors looking for bond funds with the best returns may want to look at those that are actively managed. Overall, actively managed mutual funds and exchange-traded funds fell short of passive funds, with 47% of active strategies surviving and beating their index-following peers, according to Morningstar. However, actively managed funds outperformed in the bond category. About 53% of active bond managers survived and beat the passive average in 2023, up from 30% in 2022, the research firm said in a recent report . Active intermediate core bond managers led the way with a 57% success rate, up from 38% the year prior, Morningstar found. Intermediate core bond funds largely invest in investment-grade debt, spanning from government issues to corporates. Active managers in this category tend to take more credit risk through the corporate bond market or mortgage-backed securities compared with indexed funds — and this helped them outperform last year, said Paul Olmsted, senior manager research analyst at Morningstar. "You had not only, in 2023, a higher income component of active management versus the index, you also had credit spreads tighten," he said. Core bond funds have also held up in recessions, thanks to their diversification across fixed income and duration. Duration measures a bond's price sensitivity to changes in rates, and longer-dated issues tend to have greater duration. Olmsted is a believer in active management in bonds over the long term. "They have the ability to take advantage of opportunities when they come up," he said. Here are a few actively managed bond funds that rank in the top quartile when it comes to total return so far this year, according to Morningstar. What to look for An active bond fund is going to cost you more than a passive one, and higher expenses can eat away at returns. Consider that the passively managed stalwarts in the intermediate-term bond fund category are the Vanguard Total Bond Market ETF (BND) and the iShares Core U.S. Aggregate Bond ETF (AGG) . Both are on the cheap side, with expense ratios of 0.03%, and both are toting year-to-date total returns of roughly -1.4%, per Morningstar. Meanwhile, Fidelity's Intermediate Bond Fund (FTHRX) , which is actively managed, has an expense ratio of 0.45%. However, it is holding up better than its passive peers, with a year-to-date total return of -0.4%, per Morningstar. "They are putting a lot of work into it. They are spending more time trying to find some of those good relative value opportunities that are out there," Olmsted said of active managers in the bond space. "They are employing things like credit research and other risk management tools." That said, do your due diligence and make sure high fund fees aren't cutting into your returns. Olmstead said paying between 50 basis points and 75 basis points is a reasonable fee for an actively managed fund. It's also important to hire a proven manager, he said. Make sure they have a strong record of performance versus the index, he advised. "You can't make this decision in a vacuum, either," he said. "It has to be in the context of your overall allocation and what you want your core bond portfolio to do."