U.S. Fixed Income: Big Changes in a Big Benchmark | Lord Abbett
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Market View

Over time, the proportion of U.S. government debt in the Bloomberg Barclays U.S. Aggregate Bond Index has greatly increased. What might that mean for investors?

Read time: 3 minutes

Back in September 2020, Market View took a closer look at the Bloomberg Barclays U.S. Aggregate Bond Index (popularly known as the “Agg”), widely viewed as a proxy for core bond portfolios. With 2020 in the books, and core-bond investors still assessing their portfolios for the year ahead, we thought it would be good time for an update.

The Agg posted a 7.51% return for all of 2020, but beneath this performance there were several crosscurrents at work. After a sharp selloff in risk assets in March 2020 as the COVID-19 pandemic stunned the world, the Agg proved relatively resilient on the downside, outperforming U.S. high yield bonds, U.S. bank loans, and U.S. equities during the market pullback.1 However, the swift recovery in global equity and credit markets that followed helped showcase a persistent drawback to investing in an index that has been characterized by rate-sensitivity and low yields in the past few years: its high concentration in U.S. government debt.

U.S. Federal Reserve (Fed) policy measures, coupled with a significant fiscal stimulus package passed by the U.S. Congress, helped fuel a broad risk asset rally which rewarded investors who took a diversified, multi-sector approach to investing. From March 24, 2020 though the end of 2020, the Agg underperformed U.S. equities, U.S. high yield bonds, and U.S. leveraged loans by 63.78%, 36.89%, and 21.68%, respectively.

Long known as the “broad bond-market benchmark” the Agg’s composition is increasingly dominated by U.S. government debt, as we noted earlier. Here, we’ll update how the Agg has changed over the years. And given what we view as the index’s currently unappealing yield and duration characteristics, we’ll highlight another approach fixed-income investors may wish to consider to complement a core strategy.

Hey Agg, You Look … Different

The Agg’s investment universe consists of all U.S. investment-grade fixed rate bonds, with index components for government and corporate securities, mortgage pass-throughs, and asset-backed securities. Figure 1 shows that since the 2008–09 global financial crisis (GFC), the most significant change in the composition of the index has been a large increase in the weighting of U.S. Treasury securities. This change reflects the enormous amount of debt issued by the U.S. government to help lift the nation’s economy out of a recession following the GFC, along with another wave of Treasury issuance to counter the effects of the COVID-driven market pullback in March 2020.

 

Figure 1. The Composition of the “Agg” Has Changed Greatly Over the Years
Composition of the Bloomberg Barclays U.S. Aggregate Bond Index, based on market value

Source: Bloomberg. Data as of January 29, 2021. CMBS=Commercial mortgage-backed securities. ABS=Asset-backed securities. MBS=Mortgage-backed securities.
Past performance is not a reliable indicator or guarantee of future results. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

 

Given these compositional changes, investors should be mindful of the characteristics of today’s Agg, and related vehicles such as the AGG ETF. As seen in Figure 2, over the past decade or so, the yield of the index has declined by about 75% to near all-time lows while the duration has increased by about 50% to near all-time highs. Over the years the Agg and portfolios that track the index have been increasingly dominated by government debt, increasing interest-rate risk while offering less and less yield.

 

Figure 2.  Core Bond Yields Have Declined as Duration Has Extended

Bloomberg Barclays U.S. Aggregate Bond Index: Duration and yield, January 31, 2001–January 29, 2021

Source: Bloomberg Index Services Limited. Data as of January 29, 2021 (latest month-end). The yield to worst (YTW) is the lowest potential yield that can be received on a bond without the issuer actually defaulting.
Past performance is not a reliable indicator or guarantee of future results. The historical data are for illustrative purposes only, do not represent the performance of any specific portfolio managed by Lord Abbett or any particular investment, and are not intended to predict or depict future results. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

 

We do not have to look far to see an example of how unattractive bond math can lead to yield erosion rather quickly. In just 11 calendar days from December 31, 2020 to January 11, 2021, the 10-year U.S. Treasury yield rose 22 basis points. Quick bond math shows that with the “Agg’s” current duration of 6.14 years, a 22-basis point rise in rates would have led to a negative price return of 1.35%, erasing more than a full year’s worth of yield earned from the index.    

Potential Benefits of a Flexible, Multi-Sector Approach

Considering the factors noted above, we believe a flexible, multi-sector approach can provide an attractive alternative for fixed-income investors. Such an approach could provide broad diversification across sectors, with the flexibility to adjust allocations to adapt to the market environment as conditions change.

This creates a greater potential opportunity for enhanced yield and total return potential, in our view. For a current example, the environment for credit could support additional spread tightening within the framework of a U.S. economic recovery. Therefore, credit segments that may potentially offer relative value include sectors where yields have not compressed to pre-COVID 19 levels, such as bank loans and non-U.S. high yield bonds.

Given the changed composition of the Agg, historically low yields, and duration near multi-decade highs, we think the multi-sector approach may hold increasing appeal for long-term investors.

 

1In this article, broad asset classes are referenced by the S&P 500 Index (U.S. equities), ICE BofAML U.S. High Yield Constrained Index (U.S. high-yield bonds), and the Credit Suisse Leveraged Loan Index (leveraged bank loans).

 

A Note about Risk: The value of investments in fixed-income securities will change as interest rates fluctuate and in response to market movements. Generally, when interest rates rise, the prices of debt securities fall, and when interest rates fall, prices generally rise. High-yield securities, sometimes called junk bonds, carry increased risks of price volatility, illiquidity, and the possibility of default in the timely payment of interest and principal. Bonds may also be subject to other types of risk, such as call, credit, liquidity, interest-rate, and general market risks. Longer-term debt securities are usually more sensitive to interest-rate changes; the longer the maturity of a security, the greater the effect a change in interest rates is likely to have on its price. Lower-rated bonds may be subject to greater risk than higher-rated bonds. No investing strategy can overcome all market volatility or guarantee future results.

Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that markets will perform in a similar manner under similar conditions in the future.

Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

This Market View may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

Treasuries are debt securities issued by the U.S. government and secured by its full faith and credit. Income from Treasury securities is exempt from state and local taxes.

A basis point is one-one hundredth of a percentage point.

 

Duration is a measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates.

Exchange Traded Fund (ETF) is a security that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange. ETFs experience price changes throughout the day as they are bought and sold.

Yield to maturity is the rate of return anticipated on a bond if held until it matures.

The Bloomberg Barclays U.S. Aggregate Bond Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities. Total return comprises price appreciation/depreciation and income as a percentage of the original investment.

Bloomberg Barclays Index Information:

Source: Bloomberg Index Services Limited. BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). BARCLAYS® is a trademark and service mark of Barclays Bank Plc (collectively with its affiliates, “Barclays”), used under license. Bloomberg or Bloomberg’s licensors, including Barclays, own all proprietary rights in the Bloomberg Barclays Indices. Neither Bloomberg nor Barclays approves or endorses this material, or guarantees the accuracy or completeness of any information herein, or makes any warranty, express or implied, as to the results to be obtained therefrom and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith.

The Credit Suisse Leveraged Loan Index is designed to mirror the investable universe of the U.S. dollar-denominated leveraged loan market.

The ICE BofAML U.S. High Yield Constrained Index tracks the performance of US dollar denominated below investment grade corporate debt publicly issued in the US domestic market.

ICE BofA Index Information:

Source: ICE Data Indices, LLC (“ICE”), used with permission. ICE PERMITS USE OF THE ICE BofA INDICES AND RELATED DATA ON AN "AS IS" BASIS, MAKES NO WARRANTIES REGARDING SAME, DOES NOT GUARANTEE THE SUITABILITY, QUALITY, ACCURACY, TIMELINESS, AND/OR COMPLETENESS OF THE ICE BofA INDICES OR ANY DATA INCLUDED IN, RELATED TO, OR DERIVED THEREFROM, ASSUMES NO LIABILITY IN CONNECTION WITH THE USE OF THE FOREGOING, AND DOES NOT SPONSOR, ENDORSE, OR RECOMMEND LORD ABBETT, OR ANY OF ITS PRODUCTS OR SERVICES.

 

The S&P 500® Index is widely regarded as the standard for measuring large cap U.S. stock market performance and includes a representative sample of leading companies in leading industries.

Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

The credit quality of the securities are assigned by a nationally recognized statistical rating organization (NRSRO), such as Standard & Poor's, Moody's, or Fitch, as an indication of an issuer's creditworthiness. Ratings range from 'AAA' (highest) to 'D' (lowest). Bonds rated 'BBB' or above are considered investment grade. Credit ratings 'BB' and below are lower-rated securities (junk bonds). High-yielding, non-investment-grade bonds (junk bonds) involve higher risks than investment-grade bonds. Adverse conditions may affect the issuer's ability to pay interest and principle on these securities.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett’s products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

The opinions in Market View are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. The material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy, and is not intended to predict or depict the performance of any investment. Readers should not assume that investments in companies, securities, sectors, and/or markets described were or will be profitable. Investing involves risk, including possible loss of principal. This document is prepared based on the information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

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