Bond managers need to take more risk

The information ratio (active return to active risk) measures the potential value-added by active management. High information ratios require both skill (an edge on every bet) and breadth (the opportunity to apply that skill many times over). Empirical analysis of bond mutual funds shows that top-quartile managers have positive information ratios before fees, but negative information ratios after fees, and that median active risk levels are low. The author argues that managers need to take more risk to maximize expected after-fee performance. Active duration management typically generates high risk but low information ratios. The author's analysis of potential strategies points toward opportunistic sector rotation and international investing as most promising.