With more than $4 trillion benchmarked against the Barclays U.S. Aggregate Index, the “Agg” stands alone as the market’s pre-eminent benchmark for fixed income investors.1 And yet this was not always the case. In fact, the Index was never meant to be the basis of an investment strategy at all.
The Agg was first calculated and distributed as a way for the Kuhn, Loeb & Company bond department to position its inventory to clients. Even so, the Agg remains the barometer for a large percentage of fixed income investors around the world despite dramatic growth in markets not included in the Agg. Interestingly, when many of these managers are asked why they continue to compare themselves to the Agg, the most common refrain is simply that everyone else is doing it. In today’s market environment, the efficacy of the Agg as an investment strategy continues to come under pressure.
The Agg: Near All-Time Lows for Income vs. Risk
The Agg currently provides some of the lowest levels of income potential and highest levels of interest rate risk in its history. As we show in the chart below, since 2010, there has been a marked divergence between yields continuing to fall and rising levels of interest rate risk. Despite the deteriorating trade-offs between potential yield and interest rate risk, many investors continue to hold Agg-benchmarked core fixed income positions as a hedge against deflation, equity market uncertainty and a source of income in a portfolio.
Divergence between Income Potential and Duration
Barclays U.S. Aggregate Index: Yield vs. Duration (RHS)
For definitions of terms in the chart, visit our glossary.
Market Presence May ≠ Best Value in Fixed Income
As we have long asserted, the construction of the Agg and other market capitalization-weighted benchmarks reflects issuance, not necessarily value. As a result, issuance patterns dictate sector, duration and credit tilts that are detached from a bond investor’s desire for consistent income. For example, the current composition of the Agg is over-weight U.S. Treasury securities; in fact, nearly 23% of the Agg is composed of Treasuries maturing in fewer than five years. Thus the largest sector within the Agg is concentrated in securities yielding less than 1%.2
With these potential challenges in mind, WisdomTree worked with Barclays to develop a framework that enhances the income potential of the Agg while retaining its broad volatility profile of a balanced portfolio.
In response to the low income and increasing duration risk discussed above, many investors have sought to increase the income potential of their portfolios by investing in securities outside the Agg. While we currently favor credit risk over interest rate risk, increasing exposure to non-investment-grade debt introduces new sources of volatility. As an alternative, we believe additional income potential can be secured by building from within the constituents of the Agg.