19 Oct 2026
From debt-weighted indices and changing fundamentals to market inefficiencies and forced trading, credit markets present distinct challenges for passive investors and opportunities for active management. We explore some of the key considerations.
Passive investing has transformed many areas of financial markets, particularly equities. Low-cost index strategies have attracted huge amounts of money over the past two decades, giving investors a simple and efficient way to access the markets.
But does the same passive approach work for credit? We would argue no.
Credit markets are fundamentally different from equities, and we believe they are not a natural home for passive investing. An index-based approach has limitations and distinctions that investors allocating to fixed income need to understand alongside the opportunities that active management can unlock.
The structure of credit indices is a key drawback of a passive approach. Unlike equity indices, which generally give larger weightings to companies with greater market value, credit indices typically weight issuers according to the amount of debt they have.
This means that the largest borrowers receive the highest index weights regardless of the quality of their balance sheets or future prospects. The more debt an issuer raises, the larger its presence in the benchmark becomes.
As a result, passive investors may end up with greater exposure to the most indebted issuers in the market, rather than those with the strongest fundamentals.
As credit markets are dynamic, an issuer's financial position can change quickly. This suits an active approach, where managers continually assess evolving risks and adjust portfolios accordingly as new information emerges. Passive strategies, by contrast, must hold securities for as long as they remain constituents of the index, even if their fundamentals are deteriorating.
This inflexibility can leave investors exposed to issuers with weakening creditworthiness. In addition, by the time the index catches up and a bond is downgraded or removed, its price may already reflect most of this deterioration. Passive investors may therefore be unable to avoid the increased risk of downgrades, widening spreads, or even defaults.
In general, credit markets are less efficient than equity markets. Many bonds have relatively limited analyst coverage, trading can be less frequent and prices often reflect new information more slowly.
For skilled active managers, this can create opportunities to uncover mispriced securities and relative value. Detailed credit analysis, issuer engagement and security selection enable them to exploit inefficiencies and distinguish between issuers whose fundamentals are improving and those who are deteriorating. This can be a valuable source of excess return over time and is something a passive strategy simply can’t do.
Passive credit investing can also create unintended trading behaviour because of index rules. For example, when an investment grade bond is downgraded to high yield status, it will typically exit investment grade benchmarks. Passive investors tracking those benchmarks may therefore become forced sellers, often at precisely the point when the bond’s valuation has become more attractive.
Similarly, the reverse can happen with new issues. Passive funds generally have to purchase new bonds when they enter the index, regardless of prevailing market conditions or valuations. These rules-based transactions can lead investors to sell low and buy high, potentially reducing long-term investment outcomes, while active managers can take a different view.
While passive strategies suit some asset classes, credit markets present quite different challenges. Debt-weighted benchmarks can create concentrated exposure to the largest borrowers, passive portfolios can’t respond proactively to deteriorating fundamentals, and index-tracking approaches don’t take advantage of inefficiencies.
For these reasons, we believe active management remains particularly well suited to credit investing. By combining rigorous fundamental analysis with disciplined security selection and risk management, active managers can avoid weaker issuers, identify attractive opportunities and navigate market dislocations more effectively than a purely passive approach.