Time to rethink the 'couch potato' of passive fixed-income

Why active strategies may deliver more value in 2025 and beyond

For years, model portfolios, adviser-recommended allocations, and separately managed accounts (SMAs) have leaned heavily on low-cost, daily-liquid exchange-traded funds (ETFs) that track fixed-income benchmarks. These vehicles are simple, cheap, and convenient – perfect when markets were benign and yields were falling.

But today’s backdrop – surging government debt, volatile rates, and increasing policy distortion – makes passive fixed income far less reliable.

The structural weakness of passive bonds

While there are growing concerns surrounding passive equity investing, on the surface, passive equities have a sound argument: as companies grow their earnings, index weights naturally tilt toward winners.

Bonds are different. Fixed income benchmarks allocate capital to the largest borrowers, not the strongest credits. That means passive investors systematically lend the most to the most indebted governments and companies – precisely where the risks are rising.

Low-cost, in this case, comes with hidden risks. Passive fixed income is cheap for a reason.

An era of intervention

As Professor Russell Napier (founder and course director of The Practical History of Financial Markets at The Edinburgh Business School) and others have argued, the next decade may see governments leaning heavily on yield-curve control and financial repression to manage their bloated debt loads. If bond markets are no longer free markets, then passive strategies – locked into benchmarks – become forced buyers of mispriced debt. Active managers, by contrast, can reposition across credit sectors, duration, and geographies to protect capital.

Where passive falls short: Volatility and concentration

When inflation surprised in 2022, passive bond investors endured double-digit losses as long-duration benchmarks collapsed. Bonds failed to hedge equities precisely when they were most needed. Passive strategies had no defence.

In equities, investors also face benchmark concentration – performance dominated by a handful of mega-cap stocks. But in fixed income, even small shifts away from the benchmark – adjusting duration, managing credit exposure, exploiting liquidity dislocations – can drive meaningful and consistent outperformance.

Active fixed income: More alpha per fee

If investors are going to pay for active management anywhere, fixed income may deliver the highest “alpha per fee.”

Recent results underscore this:

• Equities struggled: Only 38% of active stock-pickers outperformed their benchmarks in 2024, according to S&P Global’s SPIVA Scorecard. U.S. large-cap equity underperformance hit 65%.
• Bonds were different: The majority of actively managed global fixed-income funds outperformed their benchmarks in 11 of 16 categories – with less underperformance overall (41%) compared to equities.
• Australia stood out: In the Australian Bonds category, only 30% of active fixed income managers underperformed in 2024 (26% in 2023). On an asset-weighted basis, active managers returned 3.9% vs. 2.9% for the S&P/ASX Australian Fixed Interest 0+ Index – a notable edge in a conservative asset class.

These results highlight that fixed income alpha can be more consistent, more repeatable, and more valuable than equity alpha – making active fees in bonds more defensible.

Advisers and consultants have understandably leaned on low-cost passive ETFs for fixed income allocations. But as debt burdens rise, volatility spikes, and policies distort the market, those “cheap” exposures could prove costly.

Active fixed income offers investors a way to:

• Reduce exposure to over-levered issuers
• Navigate policy interventions like yield curve control
• Smooth portfolio returns with small, deliberate deviations from benchmarks
• Generate more alpha per fee, relative to equities

In a new era of debt and intervention, active fixed income should be viewed not as an expense, but as a core source of durability and value in diversified portfolios.

Michael Armitage CAIA is principal of Fundlab Strategic Consulting Pty. Ltd.