The decade long bull market has made a strong case for passive investing in equities, and some of this sentiment has convinced many fixed income investors to do the same. But the arguments for passive equity investing don’t fly for passive fixed income investing. As economic growth slows in the U.S. and around the world, it may be signaling the end of the current credit cycle, which may increase risk for passive fixed income investors. A better choice may be to consider nimble and flexible active managers who offer a more selective approach offering greater defense against economic recession.
Diminishing credit quality
Many investors consider the BarCap Aggregate to be the bond world’s analogue to the S&P 500®. But this is a foolish assumption. The only thing they have in common is that they’re comprised of securities issued by larger companies. Their risk characteristics are quite different.
Weightings in the S&P 500® rise and fall with the market capitalization of the companies that comprise the index. Conversely, weightings in the BarCap Aggregate reflect the total outstanding debt each company issues, subject to the index’s credit quality standards.
Here’s the problem. In recent years, many lower-rated companies in the index have taken on more debt, which is giving these companies higher weightings in the index.