No joke: Be active in your views on passive investing

The ongoing debate over active vs. passive investing appears to be nearly as enduring – and almost as animated — as “The Simpsons”, the television sitcom in which the indomitable Bart Simpson has been 10 years old for more than 20 years.

But some of the entertainment factor fades when you study the relative merits of passive investing in fixed income versus equities.  When it comes to broad exposure to fixed income, the typical bond indexes present some challenges.  Both market conditions and the constraints in how bond indexes are built can contribute to this challenge. Large and illiquid indexes don’t always translate to effective passive strategies. The collective characteristics of a bond index also change as new issues mature and old bonds are gradually replaced with newer debt.

The makeup of bond indexes also is affected by the fact that corporations or governments that issue the most debt will, in turn, likely get a larger representation in the index. So quantity of debt, not quality, often drives the weighting of a U.S. bond index’s membership.

In a recent post on our companion blog, Helping Advisors, Russell Investments’ Todd LaFountaine provides a level-headed look at the investment challenges that can come with passive replication of the fixed income market.

The punch line: Take an active view on how passive investing fits with the particular characteristics of each asset class.