Passive aggregate bond strategies have long been default options for advisors and investors looking to defray risk in equity-heavy portfolios while adding a reliable income sleeve. However, many of the ETFs and index funds tracking the Bloomberg U.S. Aggregate Bond Index and other related benchmarks come with drawbacks some market participants overlook. Sure, those funds are homes to thousands of bonds and they usually carry microscopic expense ratios. Those products are also limited in a variety of ways, though, indicating active management may be more appropriate for those seeking enhanced fixed income outcomes.

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Among those limitations:

• The Agg hasn’t added a new corner of the bond market in 40 years;
• It can only include bonds rated by the major ratings agencies;
• It excludes floating-rate debt; and
• It has a heavy concentration in U.S. Treasuries agency mortgage-backed securities (MBS), and investment-grade corporates.

Then there’s the matter of rate risk.

“The U.S. Agg is heavily skewed toward interest rate risk, with little exposure to credit spread risk,” according to Janus Henderson. “While this might be appropriate for some clients, we have found that many investors’ goals are not effectively achieved by portfolios with unbalanced risk exposure.”

The Multi-Sector Fix

Advisors and investors looking for better fixed income mousetraps can consider active management and multi-sector approaches. In fact, there may be value in pairing those two concepts.

“Over the past 5 years, the Morningstar multi-sector category has outperformed the U.S. Agg by over 3% annualized, with lower volatility,” added Janus Henderson. “In our view, the outperformance highlights the benefit of having diversified income streams and a better balance of credit-spread and interest-rate risk.”

The asset manager and ETF issuer noted that its own strategic asset allocation (SAA), which attempts to deliver a better “homebase” for fixed income investors, offers perks such as:

• Better balance;
• Increased diversification against a broader range of bonds; and
• A deeper focus on both credit and interest rate risk that can provide better risk-adjusted returns over the long-term.

Advisors should consider that today’s clients are more sophisticated than ever. They want flexibility, not the rigidity some old guard, pure beta bond ETFs subject them to.

“The rigid and static nature of benchmark indices means they do not necessarily cater to a range of client objectives, making them a less-than-ideal home base or starting point for many investors,” concluded Janus Henderson.

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