Investing in corporate bond mutual funds can feel like trying to navigate a dense fog, where the path ahead is obscured and uncertain. While the usual hot topic is all about stocks and which ones to buy and sell, corporate bond mutual funds sit quietly in many investment portfolios, offering steadier returns without the white-knuckle ride of the stock market.
But what exactly is a corporate bond fund? Corporate bond funds take money from lots of people and use it to buy bonds from companies. These bonds are like promises from companies to pay back the money with interest, letting people invest in many of these promises at once, which can provide a steady income.
But how can investors tell if their corporate bond fund is performing well? Because as it turns out, even financial experts don’t always agree on the best way to measure a fund’s performance. That's the question Walton College Associate Professor of Finance Timothy B. Riley and Yuekun Liu of the University of Manchester set out to answer in their 2025 study, "How should we measure the performance of corporate bond mutual funds? Evaluating model quality and impact on inferences."
By analyzing more than 1,100 funds’ performance over nearly 30 years, Riley and Liu uncovered some surprising insights. Investment-grade corporate bond funds—typically seen as safer and more stable—performed better than previously believed. However, they also concluded that fewer fund managers exhibit exceptional skill than earlier studies implied, with most struggling to consistently outperform the market.
Rethinking the Role of Benchmark Indexes
One intriguing revelation was that funds where managers take a more hands-on, active approach tend to outperform those that stick closer to their benchmark indexes. Benchmark indexes are standardized collections of bonds that serve as reference points for the overall market or specific sectors—think of them as the "average" performance that passive funds try to match. Many passive funds simply mirror these benchmarks, buying the same bonds in the same proportions. Riley and Liu’s findings push back against the common belief that passive investing is always best, especially in efficient markets like bond funds, where many experts say it’s nearly impossible to consistently beat the market.
Perhaps the most critical takeaway from this study is how drastically a fund's performance rating can change depending on which measurement tool is used. It's like measuring the same house with uneven measuring tapes: each one will calculate a completely different square footage. That’s why having a reliable, proven method matters—whether for everyday investors choosing funds, financial advisors offering guidance, or researchers examining market trends. Riley and Liu’s research cuts through the noise and offers a smarter path forward for investors and researchers alike by providing some much-needed clarity on this critical issue.
Finding a Better Measuring Tape
Riley and Liu’s main goal was to find the most effective way to evaluate how well bond funds are doing. They first reviewed a range of strategies that fund managers commonly rely on. From there, they examined how other researchers measured the performance of 1,137 corporate bond funds from January 1991 to December 2018. After extensive analysis, three methods rose to the top: MAT4, INDEX4, and INDEX6.
Among these, INDEX4 proved to be the clear winner. The other top methods either combined too many things together (MAT4) or split things into too many separate measurements (INDEX6). INDEX4 hit the sweet spot—comprehensive enough to capture what's important, but simple enough to be practical.
But what makes INDEX4 so special? Think of it as having the right gauges on a car dashboard. It separately tracks how government bonds, corporate bonds, mortgage securities, and high-yield (à la riskier) bonds are performing. So, like a good dashboard, INDEX4 gives a complete bond performance picture without overwhelming fund managers with unnecessary details.
Here’s why that matters: when the researchers applied the INDEX4 method to nearly 30 years of real-world fund data, they discovered some eye-opening insights that challenge conventional wisdom:
1. Investment-grade bond funds (the safer, more stable ones) actually perform better than previously thought. This is great news for people who’ve invested money into these types of funds.
2. Fewer fund managers than previously believed actually have the "magic touch" when it comes to outperforming the market through skill rather than luck. This suggests investors should be more skeptical of claims about exceptional fund manager talent.
3. Funds where managers take a more hands-on, active approach consistently deliver better returns than funds that passively follow market indexes. This challenges the popular belief that active management doesn't add value to bond markets.
Perhaps most importantly, these findings show that how bond fund performance is measured dramatically affects fund managers' understanding of which funds are truly delivering value.
Why this Research Matters
By offering a more productive approach to assessing bond fund performance, this research holds significant value for investors, fund managers, and regulators. By showing that the INDEX4 model is the clearest way to identify funds that are truly delivering value, this research contributes to:
- Improved investment decisions: Proper measurement of funds leads to more informed choices about which funds to invest in
- Better market optimization: Identifying the best fund managers ensures that capital is directed to the most effective investments
- Informed regulatory decisions: A deeper understanding of bond fund performance enables regulators to create rules that benefit the entire market
Riley and Liu’s research is, however, just the starting point, as there’s always room for further improvement. Future evaluations could take into account additional factors, such as liquidity and the ease of buying and selling bonds, which may influence bond fund performance. Their diligent research paves the way for more effective bond fund audits, enabling investors to make better-informed decisions and approach their investments with greater confidence.
