The traditional view of portfolio risk revolves around its divergence from a benchmark — most often the bellwether Barclays U.S. Aggregate Index, or simply the "Agg." This belief is flawed, however, because it ignores how individual securities, found both in and outside the index, can represent different forms and intensities of risk.

At Putnam, we break down the risks of fixed-income investing into four major areas: term structure, credit, prepayment, and liquidity.

Term structure
The sensitivity of a bond's price to changes in interest rates, which causes bonds to lose value when rates increase.
Credit
The loss of principal or income when a borrower cannot make a payment or fulfill other obligations.
Prepayment
The early, unscheduled return of principal, which may impact the expected yield or return of a bond.
Liquidity
The lack of marketability of a security, which may cause an investor to concede a lower/higher price to sell/buy a bond.

When we filter the Agg through this understanding of risk, moreover, we find that the index is heavily tilted toward term-structure risk while the other three risk categories are less well represented or nearly absent.

Nearly 80% of the Agg is government backed, and the vast majority of its performance is driven by interest rates

Traditional allocation by sector when analyzed for portfolio risk reveals risk concentrated in term structure.

Sources: Barclays, Putnam Research, as of 3/31/13.