The Passive Wave Is Coming to Fixed Income

A survey of pension funds and institutional investors found increasing demand for indexing and ETFs within fixed-income portfolios.

Benjamin Girette/Bloomberg

Benjamin Girette/Bloomberg

Institutional investors are increasingly moving toward bond index funds, including increased adoption of exchange-traded funds after the Covid-19 pandemic.

A recent State Street Survey of 358 global institutional investors — 82 percent of whom were from pension funds — concluded that passive investing in fixed income may be approaching an “inflection point.” In the survey, 66 percent of global respondents said they will prioritize the use of indexing for broad or liquid core fixed-income exposures in the next three years.

“The reason you want more allocation to indexing is for all the reasons why indexing makes sense: liquidity, you can easily get in and out of markets and decide what exposures you want,” Gaurav Mallik, State Street’s chief portfolio strategist, told Institutional Investor.

Sixty-three percent of respondents said they will also use passive approaches for less liquid, non-core fixed-income exposures over the next three years. Mallik attributed this trend to the liquidity benefits of indexing, as well as some general disappointment with returns from active managers within more complex fixed-income segments, such as high-yield strategies and emerging market debt.

In fact, 44 percent of surveyed investors said their institutions planned to increase their allocations to high-yield index strategies, while 36 percent said the same about emerging market debt strategies. The respondents cited lower costs and improved efficiency, desires to maximize the impact of asset allocation decisions, the increasing difficulty of adding alpha through active management, and enhanced liquidity and pricing transparency as the key drivers for increasing indexing in fixed income.


For institutional investors seeking out additional liquidity, ETFs felt like an obvious option for inexpensive, liquid exposure. The onset of the Covid-19 pandemic in March 2020 placed many investors in a “liquidity crunch,” which Malik said prompted investors to seek out more transparent and liquid strategies.

According to the survey, 71 percent of investors have a “strong” or “very strong” appetite for increasing ETF use for core fixed-income strategies. For non-core strategies, that figure was 48 percent.

James Clarke, managing director at credit firm Blue Owl Capital, said the survey’s findings are largely consistent with his institutional clients’ recent approach to fixed income. Specifically, Clark said he believes the percentage of core and non-core fixed-income exposures to indexing will increase in the future. But, Clarke said he has noticed a trend over the past five to seven years in which more sophisticated institutions are moving from passive-friendly asset classes and index exposure to more inefficient markets.

“Investors are moving from markets where the ability to generate excess return is harder because you’ve just got so many participants, and your returns are very much pegged to the beta of the market,” Clarke said. “And then they go to active, inefficient asset classes, like private assets, where you may not have the same capabilities, but also where there’s less competition, and where the opportunity for outsized returns is higher.”

From Mallik’s perspective, institutions are looking for a healthy mix of indexing and active asset management: “At one point in time, most people would be saying all the assets were going to active managers and cavities like high-yield and emerging market debt. Now, increasingly, the investors say that we want to get a mix between indexing and active across the board.”

In general, institutional survey respondents expressed a lack of satisfaction with their entities’ current fixed-income strategies: Less than half of survey respondents said they were “somewhat satisfied” or “extremely satisfied” with the performance of their actively managed strategies, indicating a general appetite for change.