The Bond Market's Changing Face
Heartland & Co.
By Tom Seay
March 7, 2012
As the bond market has evolved, so too have the benchmarks that are used to measure its performance. The Barclay’s Capital Aggregate index (BarCap index), perhaps the most widely-used measure of U.S. taxable bonds, is a case in point. When the BarCap was first introduced in the early 70’s, corporate debt represented about half of the index, reflecting Corporate America’s prominence as an issuer (1) . however, in the years since, the borrowing needs of the U.S. Government have grown more dramatically than other issuers – so much so that its debt now represents 70%+ of the index and is growing, while corporate debt has shrunk to a 20% weighting (2) .
This fact has significant implications for investment committees and investors who use the BarCap index to influence policy guidelines and measure success. This is especially true in passive investing in which the index is the investment strategy. As a policy tool, the changing index weightings are guiding investors to increase holdings of U.S. government debt in a period of rising debt levels - to a borrower with an increasing debt to GDP ratio - in an economy with slow to moderate growth outlook. This is the equivalent of loaning money to a corporation whose rising debt burdens cannot be supported by its current revenues and that is operating in an industry that cannot deliver the growth to dig out of a rather deep hole.
over the next three years, over $5 trillion in U.S. Treasury securities will mature (approximately 50% of marketable U.S. Treasury debt) and require refunding (3) . The U.S. is incurring $1 trillion+ annually in deficit spending, so the supply of Treasury securities is increasing at a rapid rate (3) . At the same time, the demand for such bonds has not been met with widespread enthusiasm. Perhaps not surprisingly, the Federal reserve has been the largest purchaser, buying 61% of net Treasury issuance (4) .
2012 is the tail end of a 30-year bull market in bonds. Traditional benchmarks have undergone dramatic changes that may encourage investment decisions that might be inconsistent with the original intent of one’s investment policy and lead one astray. Within fixed income mandates, hartland & Co. generally recommends active managers with reasonable constraints relative to the benchmark (i.e., minimum credit ratings, maximum issue exposure, currency exposure, country exposure, etc.). During a period of time when much is changing and the future environment is at best fuzzy, we believe it is wise to avail our clients to the most attractive opportunity set of fixed income opportunities. reviewing investment policies to consider expanding the universe of permitted investments for active managers and to diversify fixed income portfolios to include high yield, global, and emerging markets, in addition to traditional U.S. investment grade bond mandates, is warranted. Policy guidelines are tools we develop to help achieve client objectives. We need to ensure that the way we measure our performance in meeting those guidelines – the benchmark – is not hindering the portfolio’s ability to achieve long-term investment objectives. BarCap Aggregate Bond Index - The U.S. Aggregate Index is constructed to represent U.S. denominated, investment-grade, fixed-rate taxable bond market of securities regulated by the SEC. It includes securities from the treasury, agency, corporate, mortgage backed, asset backed, collateralized mortgage backed sectors, and agency hybrid adjustable rate mortgages. The index is considered the most widely accepted representation of the U.S. bond market.
Information provided in this article is general in nature, is provided for informational purposes only, and should not be construed as investment advice. The views expressed by the author are based upon the data available at the time the article was written. Any such views are subject to change at any time based on market or other conditions. Hartland disclaims any liability for any direct or incidental loss incurred by applying any of the information in this article. All investment decisions must be evaluated as to whether it is consistent with your investment objectives, risk tolerance, and financial situation. The performance data shown represent past performance. Past performance is not indicative of future results. Current performance data may be lower or higher than the performance data presented.
1 bogleheads.org
2 Barclays
3 TreasuryDirect.gov
4 Bloomberg
(c) Heartland & Co.
