The Bloomberg US Aggregate Index (the Agg) has a long history and is solidly entrenched as a benchmark for bond performance. However, since launching in the mid 1980s, its rules-based construction has grown antiquated and no longer delivers the well-diversified portfolio many believe it to be. Instead of accepting passive strategies that follow this index, investors may prefer strategies deliberately designed for their desired outcome — active Core and Core Plus.
Not all passive indices are created equal
While the Agg is often viewed as representing “the U.S. bond market,” it in fact captures just 52% of the U.S. public bond market. Compare that with equity indices like the S&P 500, which covers 81% of the U.S. public equity market — or better yet, the CRSP U.S. Total Market Index, which covers 96%.
The Agg’s construction follows a rules-based process conceived decades ago, at a time when data was most readily available for three primary sectors: U.S. Treasuries, agency mortgage-backed securities (MBS) and investment- grade (IG) corporate bonds. Today’s active fixed income managers have considerably more opportunities than the Agg — either by choosing bonds not represented in the index or excluding some that are. Active managers can establish deliberate sector weightings and navigate interest rate changes (duration), rather than just accepting the aggregate result of borrowers’ net issuance.
The cost of a low fee
While passive Agg strategies offer optically low fees, investors are repeatedly burned by the cost of lower returns.
In fixed income, active outperforms
JPMorgan Core Plus Bond Fund (JCPUX) outperforms the index, net of fee:1
- 94% of three-year rolling periods over the last 15 years
- 114bps average excess return (net of fee, R6 share class)
JPMorgan Core Bond Fund (JCBUX) outperforms the index, net of fee:2
- 90% of three-year rolling periods over the last 15 years
- 39bps average excess return (net of fee, R6 share class)
The Agg is not a well-diversified bond portfolio
In addition to missing large swaths of the market, the Agg rewards the most indebted borrowers by weighting the index based on how much debt an issuer has outstanding. Perversely, this mean that passive Agg strategies end up with concentrated allocations to the largest borrowers — which isn’t necessarily the camp investors should want to overweight.
Consider the shift in the Agg’s composition since 2000 — not because it better aligns the index to a stated investment goal — but simply because certain borrower types issued more debt. Sector concentrations have increased, both in percentage weighting and weighted duration:
Why does it matter?
Today’s altered allocations mean the Agg can’t perform as in decades past. Look at how prior versions of the Agg would have performed in 2022’s market. Compare that to what really happened to investors holding the 2022 version of the Agg last year:
How past iterations of the Agg would have performed in 20223
A year when: 10Y Treasury Yield +236bps | IG spreads +37bps | MBS OAS +20bps
Investors wanting a well-rounded portfolio that aligns with expectations should consider active strategies that can pursue deliberate outcomes and capitalize on long-standing fixed income return streams missed by the Agg’s antiquated construction process.
Active in action
It’s always a good idea to assess your core bond position on a regular basis. We offer a few suggestions as to how investors can improve upon the Agg.
1. Replace the Agg’s short-maturity U.S. Treasuries with short-maturity, high- quality asset-backed securities (ABS)
- 14% of the Agg is allocated to short-maturity U.S. Treasuries (1-3 years) and just 0.5% in ABS
- ABS outperformed duration-neutral Treasuries 12 of the past 13 years (since 2010)4
- Average annual outperformance = 0.74% per annum, cumulative advantage = 10% from 2010 to 20224
2. At times, avoid securities the Agg is forced to own by rule, such as low- coupon mortgages during the rapid rate increases of 2022.
- 70% of the Agg’s MBS allocation (20% of the Agg overall) is in some of the lowest coupon mortgage securities ever originated, despite their undesirable characteristics at time of issuance.
- These 2.0% and 2.5% coupons were issued as homeowners refinanced during COVID-era lows and the Agg was forced to include them by rule.
- During 2022, these low-coupon mortgages lost between -12% and -14%, far worse than high-coupon mortgage alternatives, which were down -6% to -10%.
In 2022, J.P. Morgan’s active strategies were underweight low-coupon MBS and the sector as a whole.
3. Design a more holistic approach to corporate credit
- BBB corporate credit is the last stop on the yield train for IG-only mandates like the Agg and, therefore, tends to be overvalued through time.
- 42% of the Agg’s corporate credit allocation is in BBB bonds, due to lower-quality borrowing trends.
- JPMorgan Core Plus Bond Fund benefits from designing its credit allocation with both IG and high yield, replacing a portion of BBB index bonds with a blend of A/BB.
- A 50/50 blend of A/BB creates a BBB average has consistently beat standalone BBB: Average outperformance = 1.06% per calendar year, cumulative advantage = 15%, from 2010 through YTD 2023.
Source: Barclays Live, J.P. Morgan Asset Management PRISM. As of September 30, 2023.
When analyzing foundational fixed income in this environment, it pays to consider the advantages that active strategies are designed to deliver.