Janus Henderson Investors
April 14, 2017
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Underappreciated Risks of Fixed Income’s Flagship Benchmark

Despite the broad acceptance of the Bloomberg Barclays U.S. Aggregate Bond Index (Agg) as a U.S. bond market proxy, we believe many investors may be unaware of its construction flaws and changing risk profile.

Allocations are determined by levels of outstanding debt. As the U.S. government issued more Treasury securities after the 2008 financial crisis, their weight in the index increased from 22% in June 2008 to 36% at 2016’s end. As it pertains to corporate credit, because the index emphasizes companies with the most highly levered  balance sheets, businesses with strong and improving fundamentals are often underrepresented.

Duration is at all-time highs, up from 3.71 years in December 2008 to 5.89 at the close of 2016. This is due in part to growing exposure to longer-dated Treasurys. Mortgage-backed securities (MBS) – which represent just over 25% of the Agg – also tend to extend duration in a rising-rate environment. Many corporate benchmark constituents took advantage of recently low interest rates to push out debt maturities, further extending the index’s duration.

Meanwhile, the Agg’s yield is trending lower. U.S. Treasury securities offer lower coupon payments than other fixed income instruments and typically provide little income cushion to combat interest rate increases. Similarly, MBS offer low coupons and little spread over Treasurys. It can also be argued the Agg’s corporate credit allocation isn’t providing sufficient yield cushion to absorb losses from interest-rate volatility.

The Agg represents only 48% of the U.S. fixed income market. The index excludes high-yield corporate bonds, bank loans, convertible and preferred securities, inflation-linked bonds and floating-rate securities. For corporate bonds, the index maintains an inclusion threshold of $300 million per issue, which often leads to the omission of smaller and potentially underfollowed issues.

The index relies on backward-looking construction techniques, with securities added and removed during the month-end rebalancing process. Moreover, the index depends on S&P, Moody’s and Fitch for issuer ratings. Due to their reliance on backward-looking data, these entities are often criticized for adjusting their ratings too slowly. We believe the reliance upon rating agencies creates inefficiencies from which active managers can benefit.

Active Core Plus managers typically have flexibility to exploit these inefficiencies. Periods of market repricing can create opportunities for active managers to buy securities at attractive valuations, and reposition at different points along the yield curve. Active managers can also adapt to changing market environments by dynamically allocating across asset classes, sectors and securities. These steps can help investors preserve capital and position for the next market cycle.

Chart of Active Outperformance over 1, 5, 7, & 10 years | Underappreciated Risks of Fixed Income's Flagship Benchmark | Janus Blog

Past performance is no guarantee of future results.

A Fund’s portfolio may differ significantly from the securities in an index. An investment cannot be made directly in an index.

When valuations fall and market and economic conditions change it is possible for both actively and passively managed investments to lose value.

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