Despite concerns about low yields and interest rate risk, investors continue to regard high-quality core fixed income allocations as a key component of a diversified portfolio. Boasting low management fees, bond index strategies have become an increasingly popular means of gaining exposure to core fixed income. However, passively replicating a bond index is a complicated task due to the complexities and inefficiencies of fixed income markets. As a result, bond index portfolios are not as passive as they may appear, tracking error can be higher than expected, and many fail to fully deliver benchmark returns on a consistent basis.
Robert Larkins, portfolio manager of the T. Rowe Price US Aggregate Bond Index Strategy, explains the challenges of wholly passive fixed income portfolio construction and how his slightly different approach to bond indexing seeks to overcome these obstacles with some active elements to more consistently and precisely capture market returns
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