Insights | 10 March 2017

Beware The Wu Wei of Passive Bond Investing

Executive Summary

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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Disclaimer: The views expressed are the views of Peter Chiappinelli through the period ending March 2017, and are subject to change at any time based on market and other conditions. This is not an offer or solicitation for the purchase or sale of any security and should not be construed as such. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities.
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