The pattern was repeated in the 1990s with the run up in tech firms, only to have the bubble burst in 1999, and in the next decade 2000 with financial institutions and the mortgage crisis, notes Walsh.
“Now we get up to where we are now and it’s government securities that are the overweight,” Walsh says. “If an advisor or an asset manager is simply investing naively along side the Agg, they’re potentially adding risk to their portfolios that they’re not even aware of, you’re not really getting the safety and security that investors seek.”
Today, much of that risk comes from interest rates. As opposed to just buying bonds outright, where the purchaser will see a return of their principal if the bonds’ guarantees are met, bond funds that follow indexes like the Agg have no return of principal guarantee. So if and when interest rates rise again, causing bond prices to fall, investors will suffer a loss in the supposedly “safe” part of their portfolios.
At Guggenheim, purposefully avoiding the Agg steers managers like Walsh away from crowded trades and poor values and towards opportunities for outperformance.
“By adding securities that aren’t in the Aggregate Index, you’re building portfolios on a relative risk basis that end up better from a safety and a total return perspective,” Walsh says. “The U.S. fixed income markets are $37 trillion in size, and less than half of that appears in an index. The Barclay’s Agg is three-fourths in government securities. We like to look for value in other places, in non-indexed parts of the market.”
Due to historically low interest rates, the Agg is concentrated in Treasuries, which means it doesn’t deliver the yields many income-focused investors are looking for.
Advisors and investors who invest in the Agg often also buy riskier portions of the market to achieve their return targets — which are usually based on the Agg’s biased past performance, says Bob Smith, chief investment officer at Austin, Texas-based Sage Advisory..
Most investors also assume that Treasury bonds are relatively “safe” investments — but that’s not necessarily the case, says Haviland.
Before 1971, U.S. Treasury bond prices and yields were stabilized by the gold and silver reserves backing federal debt, and the government controlled interest rates during times of war to prevent a ‘black swan’ volatility or liquidity event — but Haviland says that since these controls are either gone or uncertain today, investors and advisors can’t count on them when building portfolios.
Without a strong, realistic fixed income benchmark, measuring success in the bond universe becomes difficult except through comparing funds, strategies, managers and product providers to their peers. Fixed income managers are left trying to beat a flawed index, meeting investor expectations founded on an unrealistic benchmark and an investing public that still generally assumes that the Agg represents relative safety when that’s not necessarily the case.