By April LaRusse, Head of Investment Specialists, Insight Investment
The Bloomberg Global Aggregate Bond Index is one of the most widely used fixed income benchmarks. It offers a comprehensive view of the bond universe, spanning government debt, investment-grade corporate credit and securitised assets across currencies and regions. With more than 30,000 securities from thousands of issuers and a market capitalisation exceeding US$70 trillion, it arguably comes closest to capturing the scale and diversity of global bond markets.
Yet, while the Global Agg provides an essential reference point for investors, its construction reflects the mechanics of bond issuance rather than being optimised for investment returns. Unlike equity indices, where the largest weights tend to correspond to the most valuable and often most profitable companies, fixed income indices assign the greatest weight to those issuers with the most debt outstanding. Investors following the index passively are, by design, allocating capital to the most indebted borrowers.
Even worse, issuer quality has deteriorated over recent decades, with BBBs now comprising nearly half of the index’s corporate component. These bonds are more prone to downgrade, and if they fall to high yield, they are removed from the index. Passive strategies then typically become forced sellers, often at the worst price point.
For active managers, however, these same inefficiencies create opportunity. Periods of market volatility, often triggered by macroeconomic shocks or geopolitical events, tend to amplify pricing dislocations. Evidence suggests that higher levels of volatility in credit markets have historically been associated with greater opportunities for active managers to generate excess returns. In this context, the Global Agg should be viewed as a starting point for returns, a broad universe from which skilled managers can position to generate benchmark beating returns.
There are several distinct strategies that active managers can employ when they seek to outperform the index. The first is duration and yield curve positioning. By adjusting portfolio sensitivity to interest rates, managers can attempt to benefit from shifts in the yield curve. For example, extending duration when rates are expected to fall or targeting maturities that offer better relative value can potentially enhance returns versus a static benchmark. By removing forward guidance, a policy other central banks may eventually adopt, Fed Chair Warsh may inject greater front-end volatility into US rates markets, expanding the opportunity for active managers.
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Security selection is another key tool for an active manager. Fundamental analysis helps identify creditworthy issuers with solid business plans, rather than allocating to companies based on the scale of their debt. The most attractive maturities can then be targeted, especially valuable when credit curves are steep.
The primary market also offers opportunities through new-issue premia. Companies typically issue new debt at a yield premium to attract demand, and as existing bonds mature, regular refinancing ensures a steady flow of new issuance. As these bonds become eligible for index inclusion, their yields may often compress towards market levels, potentially resulting in a capital gain for investors with the flexibility to participate early.
Beyond individual securities, market structure itself provides opportunities. Bond markets are highly fragmented, with issuers often having multiple securities across different currencies, maturities and legal structures. This fragmentation can lead to pricing inconsistencies, which active managers can seek to exploit through relative value analysis.
Sector allocation is another important lever. Managers can tilt portfolios towards sectors with improving fundamentals and away from those facing headwinds. The AI infrastructure buildout is a good example, with heavy funding needs causing parts of the technology sector to cheapen relative to similarly rated issuers.
Closely linked is the concept of beta management. The credit risk of the index is fixed, but there is no reason for an active manager to replicate it. Instead, credit risk can be dialled up or down depending on the view of the credit cycle, valuations and macroeconomic conditions.
Relative value strategies extend this flexibility across markets. Differences in pricing between countries, regions or segments of the fixed income universe can create opportunities to overweight more attractive areas and underweight those offering less compensation for risk.
Finally, inflation-linked bonds provide a mechanism for managers to express a view when they believe inflation markets are mispriced. By adjusting exposure between nominal and inflation-linked securities, managers can position portfolios to benefit should market consensus change. Recent volatility in energy markets, fuelled by fears of Strait of Hormuz disruption, illustrates how rapidly inflation expectations can reprice.
Together, these strategies highlight the breadth of opportunities in global fixed income. The size and complexity of bond markets create frequent pricing inefficiencies, allowing active managers to target multiple sources of return. If successful, performance can be built incrementally, and portfolios designed with embedded resilience.
While passive strategies remain bound by index construction, active approaches can adapt, reposition and exploit dislocations as they arise. This allows them to move beyond the inherent limitations of an index with the aim of delivering more consistent performance over time.
