Text on screen: Quick Takes - Why core bond indexes are riskier now
Scott A. Mather, CIO U.S. Core Strategies: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 in the charts,
Chart: A bar chart show an increase in duration for interest rate risk in December 2008 and June 2019.
the broad market index 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,
Chart: A bar chart shows an increase in the percent of U.S. aggregate market value (BBB credit and all other credit) in December 2008 and June 2019.
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.
Chart: A bar chart shows a decrease in yield compensation for risk in December 2008 and June 2019.
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.
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