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Time To Ditch The Bond Benchmark?

Time To Ditch The Bond Benchmark? by John Taylor, AllianceBernstein

Bond indices’ limitations as investable strategies are evident when taking a closer look at a key proxy for global investment-grade bonds—the global aggregate index.

Fixed-income indices can provide useful snapshots of fixed-income markets. But they have big limitations as investment strategies. There are shortcomings even in global, multisector and multicurrency indices that, in theory, effectively blend interest-rate and credit exposure to prove good diversification to the ups and downs of equity markets.

The global aggregate index—usually known as the global agg—comprises more than 15,000 securities across 70 countries and spans investment-grade government, corporate and mortgage-backed bonds. As such, it’s widely viewed as a one-stop shop for global fixed-income exposure. Lots of index funds and exchange-traded funds try to replicate the performance of the agg—and many actively managed strategies are closely tethered to it. But how will agg-centric investment strategies hold up when global bond markets face their next big jolt—higher US interest rates? And how might they perform if there’s further significant equity market volatility?

The Seven-Year Itch

In our view, the answer is: much less robustly than in the past. Big changes in global bond markets in the years following the global financial crisis (GFC) in 2008 have significantly altered the make-up of many global fixed-income indices, including the agg. Three big trends have unfolded:

  1. Bond markets have broadened and deepened, but the agg has become more homogeneous. In the bond world, tracking a market-weighted index like the agg gives investors greatest exposure to whoever...