Rethinking The Barclays Aggregate As An Investment

December 30, 2011

Rethinking The Barclays Aggregate As An Investment

After a two-year uninterrupted trend of net inflows, the amount of money flowing into bond funds has exceeded the cash that went into stock funds during the Internet bubble. Inflows slowed down a bit after Pimco bond guru Bill Gross publicly turned uber-negative on U.S. Treasurys—but not before investors poured more than $500 billion into bond funds, fueling a rally that eventually drove two-year Treasury yields to an all-time low of less than 0.5 percent. To put that into perspective, total bond net inflow for the previous 10 years combined was only $423 billion. According to the Investment Company Institute, while equity mutual funds saw outflows of more than $63 billion, fixed-income funds saw more than $87 billion in inflows during the first nine months of 2011. Much of this inflow was invested in a single index—the Barclays Capital U.S. Aggregate Bond Index.

The bond market is more than twice as big as the stock market, but there’s never been the sentiment that bonds should be given the same attention to implementation as stocks. Inexplicably, investors don’t show the same level of consideration and differentiation to the bond portion of their portfolio as they do their equity stakes. Fixed-income portfolio management is very much an index-relative game: Incremental sector, quality and duration bets are all made with an eye to how the index is constructed. Very rarely is a benchmark-unconstrained fixed-income manager seen. Relative to equities, there’s a disproportionate tilt toward completely passive investing in fixed income, and the Barclays Capital U.S. Aggregate Bond Index is widely considered the best benchmark for efficient asset allocation.

Charles Dow may have created his Dow Jones Transportation Average way back in 1896, but total return bond indexes weren’t developed until 1973. The great portfolio innovations of the 1950s and 1960s that addressed asset allocation could not be applied without a measure of bond performance, so Art Lipson at Kuhn, Loeb created a bond index to close this measurement void. Salomon Brothers followed with a similar index two weeks later but it never really caught on. By the time Lehman Brothers purchased Kuhn, Loeb at the end of 1977, Art’s original index had already become the bond benchmark, and history has solidified this claim.

Known as the Barclays Capital U.S. Aggregate Bond Index since Barclays Capital took over the index business of the now-defunct Lehman Brothers, the “Barclays Agg” comprises about $15 trillion worth of bonds and is designed to include the whole landscape of domestic, investment-grade, fixed-income securities traded in the United States. Employed in both active and passive approaches, this “sacred cow” index is a flagship benchmark that plays an integral part in the fixed-income world; and the stampede of money flows into fixed income in recent years has made it even more so. There are over 110 generic bond indexes but practically everybody uses this one index.

Debt indexes have become not only measurement tools, but financial products in themselves—just take a look at the still-young ETF industry. The iShares Barclays Aggregate Bond ETF (NYSE Arca: AGG) is the world’s largest bond ETF, with assets of $13.8 billion, and considered by many investors to be a “one-stop shop” for fixed-income exposure. However, there are three other U.S.-listed ETFs tied to the Barclays Agg; with AGG included, their total assets amount to $27 billion as of the end of October 2011. That’s more than 16 percent of the total assets invested in U.S.-listed domestic fixed-income ETFs—115 funds in all.

Investors building a traditional 60/40 portfolio may own as many as 10 different funds to cover their equity exposure, but often have been using the Barclays Aggregate as a placeholder for years—utilizing the fund as the sole component of the fixed-income portion of their portfolio (and often not even considering the international bond market, but that’s another topic entirely).

This index—which is basically the fixed-income analog for the Russell 3000—is more than just a key touchstone in the bond market. It underpins the strategic and tactical asset allocation of billions upon billions of dollars, but America’s unimaginably massive budget deficits combined with the unprecedented government intervention in U.S. financial markets in 2008 have meaningfully changed the nature of an investment in this benchmark. Most investors are well aware of the impact such astronomical borrowing has on the country’s budget, but few have considered the impact these programs have had on this fixed-income benchmark—an impact that highlights one of the index’s key problems.


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