The case for fixed-income index funds

By ROBIN POWELL

One way to turn a myth into accepted wisdom is to keep repeating it. As the late Nobel laureate Daniel Kahneman put it in his book, Thinking Fast and Slow: “Familiarity is not easily distinguished from truth. Authoritarian institutions and marketers have always known this fact.”

Fund industry marketers have certainly known it. Just think of some of the untruths that get repeated in the financial media all the time. “Active funds produce much better returns in equity markets that are less well researched.” (They generally don’t.) “You have to use an active manager if you want to invest in a socially and environmentally sustainable way.” (You don’t.) Or, “Active funds provide downside protection in falling markets.” (Again, not true.)

Another myth that has gained credence through frequent repetition is that bond investors are better off using active funds.

Sure, it’s true that investors are less familiar with fixed-income index funds than they are with equity index funds, and that active funds have a larger share of the bond fund market than the equity fund market. But both of things are changing, and for very good reason.

S&P Dow Jones Indices has for many years kept a scorecard of active fund performance around the world, called SPIVA. Although it’s the poor performance of active managers that is more likely to attract attention, SPIVA has consistently shown that most active bond fund managers underperform most of the time.

Of course, active investing is more exciting than the methodical and pedestrian process of passively tracking a market. But if you’re more interested in higher net returns than a dose of adrenaline, the evidence suggests that the case for using fixed-income index funds could be just as strong as it is for using low-cost equity trackers.

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