AQR Asset Management researchers have put out a new paper that looks at fixed income investing.

As rates have declined over the past 20 years, active fixed income managers have outperformed their benchmark index. This outperformance tends to create the appearance that beating the fixed income markets is easier than beating the equity markets.

The assumption does not hold true when held up to the light of vigorous examination. Jordan Brooks, Tony Gould, and Scott Richardson of AQR found that there is very little skill, either individually or collectively, in fixed-income asset management over the past two decades.

AQR Asset Management on Risk Factors

The higher returns are the result of classic risk factors such as credit quality, emerging versus developed markets, and maturity. The more risks the manager took on, the more they appeared to beat the fixed-income indexes.

Taking on more credit risk by investing in lower-rated bonds was the most pervasive “risk-on” strategy that beat the index. The excess returns are merely a function of high risk equaling higher reward rather than any actual alpha generation on the part of the fund managers.

The trio also found that managers taking increased risks with their client portfolio often undermined the client’s attempts to diversify among asset classes. This lack of diversification can be masked when markets are behaving. However, it will become quite apparent when fixed income markets move lower. The active portfolios will have lower returns than the index as the increased risk leads to increased volatility and lower returns than the US Aggregate Bond Index.

You can download the complete paper here.