The short answer to the question in the headline of this story is: yes, some are. But investors and advisors have to be very selective to find the ones that provide value. High management fees often erode the mid- to low single-digit gross returns. Moreover, bond index funds, because of their low costs, have a performance advantage.

But that is not the end of the story, for bond management is a subtle process that involves not just engineering a good return but also controlling volatility, estimating responsiveness to changing economic environments, judging strategies and maintaining liquidity.

The problem for the advisor, as well as the investor, is to figure out the characteristics of funds.

The problem is choice. There are 330 Canadian fixed-income funds, many of which are clones sold as seg funds and funds that allow advisors to charge wrap fees. In a low-return environment, each cost variation makes a big impact on net return.

Fund analyst Dan Hallett, president of Windsor, Ont.-based Dan Hallett & Associates Inc., is sanguine about the vast number of funds competing in the Canadian fixed-income space. “Fees are high, and therefore provoke a lot of fund proliferation,” he explains. “The vast majority of bond funds are playing in the same universe — investment-grade bonds for which the portfolios tend to be homogeneous.”

It looks like picking petals off daisies, but beneath many similarities, there are important differences.

The baseline for comparison is return, which is low these days. For the 12 months ended March 31, the average return on a Canadian fixed-income fund was just 3.7%. Returns were modest because the 1.8% median fee on bond funds took 47% of the gross return. Those fees caused the vast majority of funds to underperform their benchmark, the DEX universe bond total return index (formerly the SC universe), which returned 4.5% for the same period.

A few fixed-income funds managed to beat their benchmark because of more successful management or low fees. In the winner’s circle were, among others, Toronto-based Mackenzie Financial Corp.’ s Mackenzie Sentinel Bond Fund M, with a 5.2% return; and Beutel Goodman Income Fund, sponsored by Beutel Goodman Managed Funds Inc. of Toronto, with a 6.8% return for the period. Mackenzie beat the index with good management, overcoming its 1.1% MER. Beutel Goodman had good management and a below-average MER of 0.8%.

One other entry, RBC Canadian Bond Index Fund, sponsored by RBC Asset Management Inc. of Toronto, produced a 7.3% return with a 0.7% MER and no management strategy whatsoever.

The three funds show that there are three ways to get a good return in bonds. They are: terrific management, which is combining good management and low fees, as Beutel Goodman did; using strong management with moderate fees, as Mackenzie did; and low fees and index replication, as in the RBC fund.

Knowing the winners is good information, but that is after the fact. The problem, of course, is to predict them. Here, the analysis becomes more nuanced, for it is management characteristics as well as fees that help to predict returns.

Edward Jong is vice president for investments with MAK Allen & Day Capital Partners Inc. in Toronto and portfolio manager of frontierAlt Opportunistic Bond Fund. As he explains, adding value to a bond index takes many skills. “The manager has to be able to forecast the direction of interest rates. He also has to be able to forecast the shape of the yield curve. If it is a global bond fund, the manager has to be able to see over the horizon and anticipate where currencies will be in a year. He needs trading instincts. He needs to do credit analysis. Most of all, he needs conviction in his call on interest rates.”

Adds Michael McHugh, vice president and bond portfolio manager with Dynamic Funds Man-agement Ltd. in Toronto: “A successful bond manager needs to have a defined process. That could be a trading strategy or a decision to take a place on the yield curve or a decision on what kinds of bonds to hold — inflation-protected or conventional, for example — and how much to allocate to each bond based on expected outcome. The manager should also have a record for doing well in both good and bad markets, and the kind of ability to adapt to changing conditions that prevents the fund from running into a prolonged bad spell even while the market is improving.”

@page_break@Strong management shows up when interest rates spike. That’s when a well-run fund can shorten its terms and avoid a lot of damage. Index funds, of course, just get trampled in this scenario.

Fund traits are identifiable by looking at a fund’s record through at least one cycle of rising and falling interest rates, McHugh says: “You don’t want to rely heavily on a manager who has experienced only half a cycle.”

Each of these predictive skills can differentiate a fund from its benchmark index. But bond fund managers do not, as a rule, explain their strategies. Indeed, in advance of trends, they may not know them.

There are, nevertheless, ways to separate the index-huggers from funds that are managed with whatever skills the manager can muster. Advisors can discern which bond funds are index-huggers by comparing their duration, which is a measure of sensitivity to interest rate changes, to the duration of the DEX index duration.

DEX universe index duration can be found at www.canadianbondindices.com. Individual fund durations can usually be found at companies’ Web sites or by asking client services departments. Beutel Goodman, for example, lists fund durations at www.beutel-an.com/MutualFunds/ExpressSheets.

If a fund’s duration is shorter than the index, it could mean that the fund manager is defensive or that he expects the central bank to lower rates. If the duration is longer than the index, it could mean that the manager wants to ride an expected drop in interest rates or inflationary expectations.

Fund managers who think that business conditions are improving tend to raise their holdings of corporate bonds, if the fund mandate permits it. The Canadian bond indices Web site also indicates DEX index corporate weights on page 2.

If business conditions are worsening, the manager may underweight corporates. Bond fund holdings by type of bond are available through mutual fund reporting services and at the fund managers’ Web sites. IE