Fixed-income investors that track traditional benchmark indices may leave fixed-income overexposed to certain risks. Alternatively, there are a number of active bond exchange traded fund strategies that may provide more diversified exposure in a shifting market environment.
Traditional market capitalization weighted bond indices are weighted by a a company or country’s total tradable bonds, which means that the more indebted borrower has a greater weight in the benchmark index, reports Robin Wigglesworth for the Financial Times.
For instance, the U.S., Italy and Japan make up over half ot eh entire $42.5 trillion universe of the Barclays Global Aggregate Index, the widely observed international bond gauge. Meanwhile, Brazil, Russia, India and China only make up 1% of the index.
Looking at the U.S., Treasuries and agency bonds make up almost 70% of the Barclays US Aggregate Index. The Vanguard Total Bond Market ETF (NYSEArca: BND), which follows the Barclays U.S. Aggregate Float Adjusted Index, includes Treasuries as the largest portion of the index at 44.8%, followed by industrials 16.8%, government mortgage-backed securities 16.5% and finance 9.1%.
“Being anchored to a benchmark heavily allocated to sectors where real yields are dangerously close to becoming negative has forced investors to reassess the traditional, benchmark-driven approach to core fixed-income management,” Guggenheim Partners said in a recent research note.
Consequently, concerns over the impact benchmarks have on bond investments have pushed many investors to alternative investment styles, such as “total return” or “unconstrained” – active bond strategies that are not constrained by traditional indexing methodologies and adapt to changes in the interest rate environment.