While passive strategies work best in liquid, price-efficient markets, these conditions aren’t always met — and they certainly aren’t now. This is where active management can help investors.

Passive strategies often lack the flexibility to adapt to changing market environments. Meanwhile, active bond ETFs can offer the potential to outperform benchmarks and bond indices.

At Morningstar, Lan Anh Tran, associate manager research analyst for Morningstar Research Services, says there are two areas of the fixed income market – high yield bonds and bank loans – where a good active manager can be. a better option than an index. funds.

According to Tran, high yield bonds carry an increased risk of default. The risks are not only high, but sometimes not very apparent. Since high yield bonds do not trade on an exchange, this decentralized trading can limit the information available to investors. This leads to a high potential for mispricing in this market, which can be a serious hurdle for a passive investor.

An active manager can conduct “fundamental research to gauge a company’s risk of default rather than blindly seeking yield, whereas an indexed portfolio is forced to pay the market price,” Tran wrote. “A good active manager can also identify pockets of potential among the lower rungs of the credit rating ladder, where the dispersion of returns is wider.”

Bank lending is another area where active management can help. Like high yield bonds, bank loans carry a high level of risk, as most issuers are rated below investment grade. Although they are considered safer than high-yield bonds, bank loans also have more quirks that make them poorly suited for index funds. Their trades also take longer to settle, complicating the day-to-day liquidity needs of ETFs.

Thus, with bank loans, an active manager has the discretion to consider investments on their merits and act opportunistically.

“[A]Active managers have an edge over passive funds in the high yield bond and bank loan markets, but this logic extends to any category where liquidity may be lacking and mispricing plentiful,” wrote Tran. “Investors need to do extensive due diligence to choose the right active managers, but the likelihood of success relative to the average passive fund is higher in these markets.”

As part of its line of active exchange-traded funds, T. Rowe Price offers a line of actively managed fixed income ETFs, including the T. Rowe Price QM US Bond ETF (TAGG)the T. Rowe Price Total Return ETF (TOTR)and the T. Rowe Price Ultra Short-Term Bond ETF (TBUX).

T. Rowe Price has been in the investment industry for over 80 years, conducting hands-on research with companies, utilizing risk management and employing a team of experienced portfolio managers averaging 22 years of experience.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.