Historically, a core bond allocation tied to a traditional index such as the Barclays US Aggregate Index met multiple needs for investors. In a landscape distorted by years of artificially low rates, however, an entirely beta-based approach may no longer provide the diversification, stability and income investors seek. Moreover, the vulnerability to a rate rise that Agg-reliant investors have lived with for years – and experienced in 2013 – has not gone away.

Vulnerability to Rate Rise Persists

 


Investors now need to think much more carefully about their objectives, and about the mixture of exposures that is most likely to meet them.
What purpose do they want their bond allocation to serve? To put it another way, this is an age when fixed income investors need to redouble their focus on keeping their allocations mission-aware, a term we have borrowed from the information technology world. We use it here to describe an allocation that is

  • Configured to pursue specific objectives and
  • Able to adapt and be flexible, to mitigate risk and stay on track as circumstances change.

In the current environment, we believe that flexible, actively managed strategies, such as unconstrained and core plus, make sense for many investors. They potentially offer higher yields, better risk-adjusted returns, and meaningful diversification while at the same time they seek to reduce overall volatility. For those institutional investors with the mission of pursuing risk-adjusted returns while managing interest-rate risk, the advantages of using a flexible strategy for their fixed income allocation are clear. A look-back model portfolio exercise focusing on 2012, 2013 and 2014 shows that BlackRock’s unconstrained and core plus fixed-income strategies either outperformed Agg-only allocations or were superior to them at capital preservation, during these differing interest rate and market environments.

The Agg’s effectiveness as an equity diversifier has deteriorated in the low-rate climate. Moreover, actively managed strategies such as core plus may offer some of the same benefits as the Agg in counterbalancing losses from a potential equity drawdown. In our view, actively managed allocations are more likely to increase an investor’s overall odds of producing positive returns from their fixed income portfolios in this new world of investing.