With more than $4 trillion benchmarked against the Barclays U.S. Aggregate Index
, the “Agg” stands alone as the market’s pre-eminent benchmark for fixed income investors.1
And yet this was not always the case. In fact, the Index was never meant to be the basis of an investment strategy at all.
The Agg was first calculated and distributed as a way for the Kuhn, Loeb & Company bond department to position its inventory to clients. Even so, the Agg remains the barometer for a large percentage of fixed income investors around the world despite dramatic growth in markets not included in the Agg. Interestingly, when many of these managers are asked why they continue to compare themselves to the Agg, the most common refrain is simply that everyone else is doing it. In today’s market environment, the efficacy of the Agg as an investment strategy continues to come under pressure.
The Agg: Near All-Time Lows for Income vs. Risk
The Agg currently provides some of the lowest levels of income potential and highest levels of interest rate risk
in its history. As we show in the chart below, since 2010, there has been a marked divergence between yields continuing to fall and rising levels of interest rate risk. Despite the deteriorating trade-offs between potential yield and interest rate risk, many investors continue to hold Agg-benchmarked core fixed income positions as a hedge
, equity market uncertainty and a source of income in a portfolio.
Divergence between Income Potential and Duration
Barclays U.S. Aggregate Index: Yield
vs. Duration (RHS)
For definitions of terms in the chart, visit our glossary.
Market Presence May ≠ Best Value in Fixed Income
As we have long asserted, the construction of the Agg and other market capitalization-weighted
benchmarks reflects issuance, not necessarily value. As a result, issuance patterns dictate sector, duration and credit
tilts that are detached from a bond investor’s desire for consistent income. For example, the current composition of the Agg is over-weight U.S. Treasury securities
; in fact, nearly 23% of the Agg is composed of Treasuries maturing in fewer than five years. Thus the largest sector within the Agg is concentrated in securities yielding less than 1%.2
With these potential challenges in mind, WisdomTree worked with Barclays to develop a framework that enhances the income potential of the Agg while retaining its broad volatility profile of a balanced portfolio.
Barclays U.S. Aggregate Enhanced Yield Index
In response to the low income and increasing duration risk discussed above, many investors have sought to increase the income potential of their portfolios by investing in securities outside the Agg. While we currently favor credit risk
over interest rate risk, increasing exposure to non-investment-grade
debt introduces new sources of volatility
. As an alternative, we believe additional income potential can be secured by building from within the constituents of the Agg.
The enhanced-yield Index is constructed by separating the Agg into 20 components and then reweighting the exposures to maximize yield while adhering to certain constraints. Absent these guardrails, the Index would simply be over-weight credit and duration. The output, as shown below, results in greater weights to the higher-yielding segments of the market, while under-weighting the lower-yielding U.S. government allocations in the Agg.
Enhanced Yield vs. Agg Relative Sector Exposure
As a result, the yield-enhanced Index delivers an additional 70 basis points (bps)
of yield compared to the aggregate with a similar volatility profile.3
In our view, this mechanical approach enhances the desirable characteristics of the Agg, while also enhancing the income potential of the strategy. For investors needing to hit minimum income targets, this modification of the Agg could help them achieve their objectives. For managers concerned about the high-yield bond market, this approach also provides higher income potential in an all-investment-grade
In today’s uncertain market environment, investors are increasingly looking for ways to enhance the income potential of their portfolios. Through its yield-enhanced approach, WisdomTree seeks to maintain the key characteristics of a popular investment strategy while enhancing its income profile.
Source: Barclays, as of 6/30/15.
Sources: Barclays, WisdomTree, as of 6/30/15.
Source: Barclays, as of 5/31/15.
Important Risks Related to this Article
Fixed income investments are subject to interest rate risk; their value will normally decline as interest rates rise. Fixed income investments are also subject to credit risk, the risk that the issuer of a bond will fail to pay interest and principal in a timely manner or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline. Investing in mortgage- and asset-backed securities involves interest rate, credit, valuation, extension and liquidity risks and the risk that payments on the underlying assets are delayed, prepaid, subordinated or defaulted on.