Scott Mather: We think core bond investors need to pay a lot of attention to what’s happened in the broad market, what’s happened in the popular indices that many passive investors are focused on, and as you can see the overall market has become much riskier over the past decade and is much riskier now than it’s been at many points in time in history, and the reason for that is not only is it longer in duration, so it has more interest rate risk, but it also has a much higher corporate component than it has in prior cycles, since many corporates have levered up and issued a lot of corporate debt in the last decade.
So, much of the increase in maturity of that index is coming from a higher corporate component.
The corporate index is not only longer in maturity, but it’s also lower in quality, and you see that in terms of a dramatic increase in the BBB-rated corporates, and, of course, that’s the part of the portfolio that probably won’t do that well if a passive investor is just taking a broad exposure to the market in the next true economic downturn.
At the same time, look at the compensation that one gets for taking that added risk in a passive way.
Dramatically lower than it’s been in the past.
So, putting it all together, that’s the reason why we think investors should take a high-quality, diversified, but active approach to managing their core allocation.
A well-managed core bond portfolio can still provide the potential for income as well as capital gains that can offset other parts of the portfolio that aren’t doing well if we get an economic slowdown or we get the next turn in the credit cycle, but it’s increasingly important that investors focus on the quality of that strategy and not passively approach what is becoming a much more risky market.
Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Management risk is the risk that the investment techniques and risk analyses applied by an investment manager will not produce the desired results, and that certain policies or developments may affect the investment techniques available to the manager in connection with managing the strategy. Investors should consult their investment professional prior to making an investment decision.
The credit quality of a particular security or group of securities does not ensure the stability or safety of an overall portfolio. The quality ratings of individual issues/issuers are provided to indicate the credit-worthiness of such issues/issuer and generally range from AAA, Aaa, or AAA (highest) to D, C, or D (lowest) for S&P, Moody’s, and Fitch respectively.
Bloomberg Barclays U.S. Aggregate 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. These major sectors are subdivided into more specific indices that are calculated and reported on a regular basis. It is not possible to invest directly in an unmanaged index.
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