Bonds are flying under the radar: are passive or active funds best for exposure?
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Equity markets have kept investors on their toes in the last year. Between a stream of tariff announcements, policy shifts, and AI speculation, there have been more than enough factors to keep track of.
While equity markets often take the spotlight, bonds have been chugging along in the background with their own share of changes. So, what do investors considering an investment in bond funds need to know about the current environment and what’s the best way to approach this market?
How have bond funds performed over the last year?
The somewhat underwhelming star of the show over the last 12 months was corporate bonds, with global corporate bond funds generating an average total return of 4.3%. The global government bond fund sector average return was 1.3%, while global high yield bond funds averaged 1.8%.*
In the context of past returns, this is not a strong year for government bonds and an extremely weak year for high yield. Over the past 20 years, the high yield sector has averaged a return of 6.35%, a near five-percentage point difference compared with the last year. Global government bonds also typically do materially better at an average 2.9%.**
One of the reasons the past year was so challenging for high yield bonds was because of the geopolitical volatility. High-yield bonds tend to be more sensitive to these changes than other parts of the bond market, so Trump’s tariff announcements last April took a significant toll on the market. While the fall wasn’t as dramatic for high-yield bonds as it was for areas of the equity market, the recovery was more faltering. In 2025 the sector did not manage to eke out a positive return on the year until the end of September.
The shifting environment between government and corporate bonds
One topic that has repeatedly resurfaced of late is worries about government debt. These conversations have been prevalent for the UK and US. This can cause more hesitation when it comes to gilts and treasuries, which make up a significant amount of the global government bond market.
Stephen Snowden, head of fixed income at Artemis, believes the concern about the US and UK as well as the sturdiness of investment-grade corporate bonds in past years has created a possible opportunity.
“I’d say things have shifted and I’m not sure bond markets are reflecting that. To my mind that makes corporate bonds more attractive relative to the bonds of increasingly indebted governments than they were a year or two ago,” Snowden says.
“The fact that this shift is not fully priced into bond markets feels like an investment opportunity to me. I’m not saying government bonds are suddenly going to default. But the risk of government default is higher than it was.”
Default risk is of course not the only risk factor when it comes to bond investing, and Aegon High Yield Global Fund managers Thomas Hanson and Mark Benbow argue that that the ability of countries to print currency provides a large degree of flexibility around default risk.
“Ultimately a government that issues debt in its own currency will not have default risk since it retains the ability to simply print more money to fulfill its obligations. There are plenty of other risks, however, including interest rate risk, inflation concerns, and volatility associated with political noise,” Hanson and Benbow observe.
“In a risk-off scenario where a flight-to-quality effect is in full swing, there is little doubt government bonds should outperform here: duration will be your friend, and the lack of default risk will be supportive. In times of positive economic growth, with a backdrop of solid corporate fundamentals and strong technicals, it is not unreasonable to assume investment grade corporate bonds might be a better option as spreads tighten.”
Have passive or active funds been more successful investing in bonds?
Another interesting trend has emerged in the type of bond fund which has been successful. In an interesting inverse to the situation with equity funds, a recent study by AJ Bell Investments showed that active bond funds have outperformed their index-tracking counterparts.
“In bonds, we see a consistent pattern of a majority of active strategies beating benchmarks,” says Terry McGivern, AJ Bell Investments’ senior research analyst.
“The disparity isn’t massive, but our study highlighted active bond funds outperforming a representative passive benchmark in seven out of nine fixed income asset classes, over a three-year period to the end of July 2025.”
For a passive equity fund, you buy the same holdings as the underlying index. This is relatively easy to do because these are listed companies, and even the largest indices only have a few thousand names. However, bond indices often have upwards of 20,000 holdings. This is much harder for bond funds to replicate because the costs that come along with purchasing holdings eat into investor returns, and it’s not always possible to purchase the same bonds that are being held in the indices.
“The benchmark does not face trading costs and receives perfect allocations to new issues. On the other hand, the ETF must incur trading costs and is forced to buy the bonds at the current market price in an effort to replicate benchmark holdings. This turnover can result in meaningful trading costs for an asset class that tends to have a wider bid-ask spread (difference between the price at which you buy and sell],” Hanson and Benbow note.
“In times of stress, the liquidity factor may become increasingly important as replicating index holdings becomes more challenging, the ETF is forced to buy bonds regardless of the price.”
Active managers can take advantage of a more flexible approach
In addition to these technical limitations, there is also the factor of what fund managers are able to capitalise on by actively choosing their holdings. Snowden says that in bond markets there are significant inefficiencies that bond managers are able to exploit.
“That’s because one company might have dozens of different bonds on the market – of differing durations and in differing currencies. That creates a lot of short-term mispricing we can take advantage of if we’re quick and alert,” Snowden adds.
“Another reason is that passive bond funds tend to weight their holdings by the amount of debt a company has in issuance. A thoughtful investor might decide that having most exposure to the company with the biggest debt is not necessarily smart. So, a good active manager has a lot of opportunity to outperform passive bond funds.”
*Source: FE Analytics, 21 January 2025 to 21 January 2026.
** Source: FE Analytics, 21 January 2006 to 21 January 2026.
Hannah Williford: Content Writer
Hannah joined AJ Bell in 2025 as an investment writer. She was previously a journalist at Portfolio Adviser Magazine, reporting on multi-asset, fixed income and equity funds, as well as macroeconomic impacts and regulatory changes...
