There Is No Clear Core

For about three decades, US institutional investors have organized their fixed income allocations around a single idea: Core/Core Plus. This framework is anchored by the Bloomberg US Aggregate Bond Index, launched by Lehman Brothers in 1986 and known simply as ‘the Agg’.

Core acts as a fixed income portfolio’s defensive anchor. It inhabits the investment-grade, dollar-denominated universe defined by the Agg. Core Plus adds sleeves called plus sectors that help enhance portfolio returns. These sleeves include high yield, emerging markets debt, non-agency mortgages, bank loans, and global bonds.

This setup worked well for many years. However, we believe this division of labor no longer describes the risks investors hold. Two things have changed since the Core/Core Plus framework became established: the index and the credit quality behind it.

A Changed Index: More Treasuries, Longer Duration, Weaker Credit  

In 2002, US Treasuries represented less than a quarter of the Agg. Today, they account for roughly one half. With the US federal budget deficit running at almost two trillion dollars a year and little political appetite to curb government spending, that share is more likely to rise than fall.¹ Add agency mortgage-backed securities and other government-related debt, and roughly three-quarters of the Agg now rests on the creditworthiness of the US government and its agencies.

Along the way the index's duration has lengthened, from around four and a half years before the global financial crisis to about six years today. A larger Treasury weight, longer Treasury issuance, and lower coupons have collectively pushed out duration. The Agg of 2026 is not the Agg of 1986, or even of 2006. It is now effectively a Treasury index with a corporate sleeve attached.

Meanwhile, the creditworthiness of the sovereign at its center is waning. In 1980, US federal debt held by the public was about 25% of US GDP. Today, it is about 100%, and the Congressional Budget Office projects will hit 120% by 2036 (Exhibit 1). In May 2025, the US lost its last AAA rating from a major ratings agency.  The Agg moved down to AA+ two years earlier.

These facts are well known. What is less often noted, though, are their implications for Core/Core Plus fixed-income portfolios. The Core is no longer a diversified pool of high-quality bonds. It is now a long-duration position in a single issuer whose balance sheet is deteriorating.

This is not to say Treasuries no longer work. They still remain an effective hedge against growth shocks as they did during the COVID-19 sell-off in March 2020. However, the Core/Core Plus hierarchy, where sovereign debt is safe and credit is risky, made sense when the sovereign balance sheet was small and the shocks that mattered were growth shocks.

What treasuries do not hedge is inflation and fiscal shocks, precisely where the distribution of shocks has shifted. In 2022, a year that saw US annual consumer price inflation peak at 9.1%, the Agg fell about 13% while US equities fell about 18%. Essentially, the supposed defensive anchor experienced a drawdown roughly two-thirds as large as the drawdown in the risk asset (US equities) it was meant to offset.

More recently, in April 2025, Treasuries, the dollar, and US equities all sold off together for several days. That is a correlation pattern associated with an emerging market, not the issuer of the world's reserve currency. The pattern tells us something simple. When the dominant risk is the sovereign's own fiscal trajectory, we believe a Treasury-heavy Core may be limited in its ability to diversify that risk, and something outside the Core may be warranted.

Plus Sectors: Diversifiers of Sovereign Risk

That can change the job of the plus sectors. They are no longer only return enhancers. Just as importantly, they are now diversifiers of US sovereign duration and fiscal risk. But they do that job in different ways, and we think the differences matter more than the framework's vocabulary allows.

Shorter-duration credit, meaning high yield bonds, bank loans, and dollar-denominated emerging markets corporate debt, diversifies by carrying less Treasury duration. And there is a fundamental story behind it. Since the global financial crisis, especially since COVID-19, leverage has moved from private to public balance sheets in the US. Household debt relative to GDP is now far below its 2008 peak. As for corporates, their balance sheets are, admittedly, not pristine, plus there is visible stress in private credit, commercial real estate, and lower-income consumer debt. However, companies have not re-levered on anything like the scale of the federal government. The relative position has inverted. The risk the Core/Core-Plus framework assumed sat in credit now sits, to a greater degree, in the sovereign.

EM Local Currency Debt: Away From the Core

Emerging markets local currency debt diversifies through a different channel altogether. Its returns are driven by local interest rates and currencies, set by roughly 20 central banks responding to distinct inflation and growth cycles, rather than by the US yield curve and the dollar. It is, by construction, the fixed income sector least tethered to the issuer at the center of the Core.

Meanwhile, emerging markets hard currency sovereign debt, which is where most US institutional EMD allocations sit, can be the exception that proves the rule. It is priced as a spread over Treasuries with six to seven years of duration, so it carries Treasury duration inside it. In 2022, the J.P. Morgan EMBI Global Diversified fell almost 18%, more than Treasuries did. Its diversification value comes from differentiation across 70 sovereigns whose fortunes do not depend on the US fiscal trajectory, not from its duration, which it shares with the Core. That is why we believe the choice between hard and local currency, and the manager's control of duration and beta, matters more than the label EMD.

Most US investors have not made that distinction, because most still put EMD in the return-seeking bucket and leave it there. Outside the US, the conversation is different. When we talk to non-US clients, their reasons for holding EMD are couched in the language of portfolio resilience and diversification. Part of this is structural: international investors’ allocations were never anchored to a single domestic benchmark the way the Agg anchors US investors. Part of it is experience. Many non-US investors never had the luxury of treating their home sovereign as the risk-free center of the portfolio, and so they never built a framework that assumed it.

Developed World Debt Loses its Luster

France shows where the luxury ends. A G7 core sovereign is losing its core status in real time. At the end of the third quarter of this year, ten-year OAT yields reached their highest level since 2008 and the spread over German Bunds breached 100 basis points for the first time since 2012. Fitch and S&P have already downgraded France to single-A territory. For a euro-based investor, diversification away from their home currency and countries has stopped being the plus. It has become the point.

We believe the US version of this shift is a matter of when, not if, and that the trigger is the dollar. The first leg may already be behind us. The dollar index fell roughly 10% in 2025 from its January peak, and EM local currency debt was among the best-performing fixed income sectors of the year, with its returns split between local rates and currencies. Behind the cyclical move sits a structural one: the dollar's share of allocated global reserves has drifted lower, from about 71% in 1999 to roughly 57% this year. A sustained, broad weakening of the dollar, under the weight of persistent twin deficits and the gradual erosion of its reserve role, would make the diversifying function of EM local currency debt as apparent to US investors as it already is to investors abroad.

A weaker dollar would also expose the deeper problem with the framework, which is not about weights or duration but about the categories themselves. "Emerging markets" was a marketing label, coined at the International Finance Corporation in 1981 to replace "Third World." Like all labels, it carries a hidden assumption, in this case that the developed countries outside it are safe. We see the world differently.

Country risk exists on a continuum. The US sits further along it than it did a generation ago. France is moving along it now. A framework that places a single sovereign at the risk-free center of the portfolio, and everything else in a plus sleeve, was built for a world in which that sovereign's balance sheet was small, and its creditworthiness was not a question. That world no longer exists. Put simply, there is no clear Core.

EMD for Diversification Means Managing Differently

If EMD’s role in a portfolio is diversification as much as return, then the way it is managed should follow. Here the conclusion is less comfortable for our own industry than for the framework.

A high-beta EMD approach, maximizing spread and duration exposure to harvest the return-seeking premium, can deliver more of the global duration and risk-asset beta that the allocation was meant to diversify. It is the natural style for a return-seeking sleeve but the wrong style for a diversification mandate. A diversification mandate generally calls for explicit control of duration and beta, so that the allocation does not import the very Treasury and risk-asset exposure it was meant to offset. That entails differentiation of country risk across the full continuum, treating sovereign analysis as the core analytical discipline. It also means having flexibility between hard and local currency exposure, because the two diversify through different channels and their relative value shifts with the dollar and the credit cycle. It is also, in our view, what will justify a larger allocation to the asset class once the Core mentality is set aside.

The Core/Core Plus framework was a good answer to the question investors were asking in 1986: How to build a defensive anchor and add return around it? The question investors should be asking in 2026 is different: When the anchor is the risk, what diversifies it? EMD is part of the answer, but only if it is understood for what it is: fixed income of risky countries, and managed for the job it is now being asked to do.