In Taoist philosophy, there is an important concept called wu wei, which translates loosely to “doing-by-not-doing.” While Lao Tzu, the 6th century BC author of the Tao Te Ching and founder of Taoism, most assuredly was not writing about fixed income portfolios, the idea of “doing-by-not-doing” aptly applies to what we see happening in passive bond index space today. Many have extolled the virtues of a wu wei approach to investing, and 2016 was a banner year for flows into all sorts of passive strategies through index funds and ETFs. But we think this is no time for wu wei in bonds; in fact, passively getting exposure to the Bloomberg Barclays US Aggregate Bond Index (aka “the Agg”) is downright dangerous today. The Agg --- prevalent in classic “60/40” institutional portfolios and defined contribution target date frameworks --- is aggressively taking on more risk at possibly the worst possible time. (Note: We have also written extensively, more generally, on the problems with indexing a bond portfolio*). There are three main reasons for our concern: the simple math of bond duration; the changing composition of the index; and the very logical financing behavior of corporate borrowers.
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