In a prior post, Fixed Income: Coupon is King, we explored the long-term return profile of the Bloomberg U.S. Aggregate Bond Index (the “Agg”). One of the more surprising takeaways was just how modest the Agg’s outperformance has been relative to similar-duration Treasury bonds. Over multiple decades since its inception, the Agg has only delivered about 30 basis points per year more of return than Treasuries of comparable duration.
That small premium is meant to compensate investors for taking on additional risks, primarily credit and securitized exposure that feed into an illiquidity premium. But what happens when that premium becomes even smaller, as it has in the current environment? It may be time to rethink how investors approach fixed income within diversified portfolios.
The Case for Treasuries
Treasuries have several advantages over the broader Agg. First, the credit risk is effectively nonexistent, which means investors are less exposed to spread widening or default concerns during periods of market stress. Second, Treasuries typically offer superior liquidity, particularly in large portfolios or volatile markets. Third, and often overlooked, they are more tax efficient. Treasury interest is exempt from state and local income taxes, which can translate into a significant benefit for investors in high-tax states.
But perhaps most importantly, Treasury bonds themselves have historically matched the Agg within a portfolio context, given the above advantages. As the chart below shows, $1 invested in a 60% S&P 500 and 40% Agg or Treasury portfolio of similar duration has had nearly indistinguishable returns.
Where Things Stand Today
The current spread environment is historically tight. Credit spreads, the difference in yield between Treasuries and riskier bonds, are near the low end of their historical range. That means investors are getting paid very little to take on credit risk. The chart below shows just how narrow these spreads have become at the index level.
Data as of May 2025
This compression in spreads has important implications. It suggests that future excess returns from the Agg, relative to Treasuries, are likely to be even lower than the already modest 30 basis point historical average. In fact, there is a very real possibility that Treasuries may even outperform given history, particularly if economic conditions deteriorate or credit events emerge. Historically, from an asset allocation standpoint, when spreads on the Agg were less than 50 bps (20 points wider than current levels), an allocation to the Agg added nearly no incremental return.
How to Do Better
For investors who are looking to outperform, there may be a better way to approach fixed income. One potential strategy involves using Treasuries for the core bond exposure to capture the desired duration and rate sensitivity, while looking elsewhere for incremental return.
Rather than relying on tight credit spreads, investors can look to harvest other risk premia within an existing bond allocation. This could include strategies like equity option overlays to provide incremental equity exposure or to collect option premium with the objective of outperforming traditional credit. When implemented thoughtfully, these strategies can provide income and return potential while potentially sidestepping widening spreads that would make credit more attractive.
Even better, many of these alternative sources of income can be delivered in a tax-efficient wrapper, such as an ETF. That structure helps mitigate the tax burden of ordinary income and gives investors the potential to outperform the Agg in both nominal and after-tax terms.
Putting It All Together
In today’s environment, with spreads near historic lows and credit risk offering very little reward, investors may want to reconsider whether the Agg still deserves its traditional role in the portfolio. Treasuries may offer a cleaner, safer, and more tax-friendly alternative for core bond exposure. And for those seeking more, there are smarter ways to pursue additional yield and return without taking on the asymmetric risks that come with credit-heavy bond allocations.
Disclosures
Past performance is not indicative of future results. This material is not financial or tax advice or an offer to sell any product. The information contained herein should not be considered a recommendation to purchase or sell any particular security. Forward looking statements cannot be guaranteed and all calculations may change due to changes in facts and circumstances.
This commentary offers generalized research, not personalized investment advice. It is for informational purposes only and does not constitute a complete description of our investment services or performance. Nothing in this commentary should be interpreted to state or imply that past results are an indication of future investment returns. All investments involve risk and unless otherwise stated, are not guaranteed. Be sure to consult with an investment & tax professional before implementing any investment strategy. Investing involves risk. Principal loss is possible.
Advisory services are offered through Aptus Capital Advisors, LLC, a Registered Investment Adviser registered with the Securities and Exchange Commission. Registration does not imply a certain level or skill or training. More information about the advisor, its investment strategies and objectives, is included in the firm’s Form ADV Part 2, which can be obtained, at no charge, by calling (251) 517-7198. Aptus Capital Advisors, LLC is headquartered in Fairhope, Alabama. ACA-2506-61.
