Is one of the most important benchmarks on Wall Street in need of a serious upgrade?
The Bloomberg Barclays U.S. Aggregate Bond Index, the fixed-income index that is essentially synonymous with the U.S. bond market, much as the S&P 500 /zigman2/quotes/210599714/realtime SPX +0.25% is for equities, has drawn criticism from major investors and analysts, who view it as an insufficient gauge for measuring the entirety of the bond universe. It certainly has ardent defenders, and even critics of the AGG—as the index is informally known—recognize its centrality to the economy at large, as well as its adherence to its stated mission. However, they view that mission as unnecessarily narrow.
“It’s time for investors to break away from the AGG, and look for tools better suited for today’s modern investment environment,” wrote Matthew Bartolini, head of SPDR Americas research at State Street Global Advisors, in a June blog post entitled, “ Why I Quit the AGG, and Why You Should Too .”
“I don’t know that I’d say the AGG is antiquated, but it certainly isn’t representative of the universe of fixed-income assets that investors have at their disposal.”
Scott Minerd, chairman of investments and the global chief investment officer at Guggenheim Partners Investment Management
The key complaint, by both Bartolini and others: by favoring Treasurys and other securities that are rated as high quality, and by excluding a number of other categories with higher yields—categories that are often smaller, less liquid, and riskier—the AGG paints an incomplete picture of the overall asset class.
“I don’t know that I’d say the AGG is antiquated, but it certainly isn’t representative of the universe of fixed-income assets that investors have at their disposal,” said Scott Minerd, chairman of investments and the global chief investment officer at Guggenheim Partners Investment Management. “It doesn’t include a large part of the asset-backed market, which is like comparing a car from the 1960s to one built today, which has air-conditioning and power windows and computers in the dashboard.”
While the AGG may be the gold standard for bonds, there are other indexes put out by Bloomberg Barclays that track the segments of the fixed-income universe suggested by the critics. There’s also already an index that offers broader fixed-income exposure, although it isn’t nearly as popular.
More than 70% of the AGG is held in triple-A rated securities, which are viewed as the safest. Another 4.8% of the portfolio is in double-A rated bonds, while 13.8% are rated just about a notch above what is typically considered investment grade by some rating agencies. In terms of composition, nearly 37% of the index comprises Treasury bonds, according to data from Bloomberg Barclays Indices.
While some may use the benchmark 10-year note /zigman2/quotes/211347051/realtime BX:TMUBMUSD10Y 0.00% as shorthand for the overall bond market, the heavy tilt toward Treasurys and other government-related securities means that a lot of fixed-income products don’t appear in the index. A Guggenheim estimate puts the AGG at only representing 44% of the available bond universe; State Street Global Advisors says the holdings “cover just 21% of the $90 trillion global bond market.”
The current composition of the AGG arose in response to the financial crisis, when the Federal Reserve purchased hundreds of billions of dollars of bonds in a move to stoke demand for equities. The increase in Treasury debt “reshaped the core fixed-income universe,” according to Guggenheim. This led to the AGG’s weighting of Treasurys to rise by two-thirds from yearend 2007, when they represented 22.35% of the index, to their current weight of 36.96%.
“As its Treasury footprint has grown, the AGG has demonstrated a near-perfect correlation to the Bloomberg Barclays U.S. Treasury Index—hardly a diversified bond exposure,” Bartolini wrote, referring to another index that is focused on Treasurys. “This makes it hard to argue that today the AGG is anything more than a U.S. government bond index.”
While the “aggregate” name may imply comprehensiveness, Bloomberg Barclays Indices makes it clear that the AGG isn’t designed to provide exposure to the entirety of the fixed-income universe. Instead, it measures “the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market.”
It does so via an advisory council that meets to determine the composition of the index. The group has certain criteria for inclusion, including the size of the issues, how widely they’re owned, and their liquidity. Over the life of the AGG, the council has opted to add securities in certain categories—such as commercial mortgage-backed securities—that grow enough in popularity to meet the guidelines, while ones that have waned in usage—like hybrid adjustable-rate mortgages—have been removed.
“It doesn’t capture everything,” said Steve Berkley, global head of indices at Bloomberg. “Unlike equity indexes, where you can perfectly match the components with no tracking error, you can’t do that in fixed income. Bonds are traded over the counter, a lot of the bonds aren’t liquid, and they may be difficult to price.”