Inside the New iShares Yield Optimized Bond ETF

Zacks Equity Research

With the Fed having clearly stated that it is in no hurry to raise interest rates, yields are expected to remain low at least for this year. As such, yield-hungry investors are left with very few options to choose from (read: 3 Long Term Bond ETFs Surging as Rates Stay Low).

Investors have been opting for products like high-yield junk bonds or emerging market bonds to meet their yield requirements. Thus, there has been a trade-off between yield and portfolio risk as it is quite difficult to get a product that matches both criteria – a decent yield and comparatively lesser risk.

To help satisfy this search, iShares has recently launched a new fund, iShares Yield Optimized Bond ETF (BYLD), which has hit the market on April 22, 2014. The fund has garnered $7.5 million since its inception.

BYLD in Focus

The newly launched product seeks to track the Morningstar U.S. Bond Market Yield-Optimized Index, which is composed of underlying fixed income funds that collectively seek to deliver current income.

“The index seeks to optimize a portfolio of iShares fixed income ETFs to find a combination that provides the highest potential yield, while seeking a level of portfolio risk that is in line with the broader U.S. bond market,” said Matthew Tucker, Head of iShares Fixed Income Investment Strategy.

With this approach, BYLD seems to be a “fund of funds”, offering investors a wide spectrum of U.S. bond ETFs in a single fund. Notably, all the funds included are by the issuer iShares itself.

The top three funds in BYLD include iShares MBS ETF (MBB), iShares iBoxx USD High Yield Corp Bond (HYG) and iShares Intermediate Credit Bond ETF (CIU) having 29.92%, 19.79% and 18.28% of allocation, respectively.

The fund provides exposure to various categories of bonds traded in the U.S. market, such as, Government Bonds, Investment Grade Corporate or Floating Rate Bonds, Non- Investment Grade Corporate and mortgage-backed debt (read: PowerShares Launches Variable Rate Preferred ETF).

The index maintains a weight allocation of 0-50% US Government Bonds, 0-10% Inv Grade Corp / Floating Rate, 0-50% Securitized and 0-20% Non-investment grade bonds at each rebalance date. This rebalancing every quarter will eliminate concentration risk.

The product seems to focus on the middle part of the yield curve, having a weighted average maturity of 6.78 years and an effective duration of 5.14 yrs. This suggests moderate interest rate risk for the product.

BYLD charges 28 basis points as fees.

How might it fit in a portfolio?

The product is an interesting choice for investors seeking to earn higher yield, while keeping risk at bay. Moreover, the fund also provides diversification benefits by holding a variety of bonds in a single fund.

Also, given that the Fed is expected to maintain low interest rates for a prolonged period, the fund is a suitable choice for investors finding it difficult to obtain fixed income products with a decent level of yield (read: 3 Bond ETFs Surging as Interest Rates Tumble).

Even if the Fed does hike rates, the fund is not expected to take as hard a beating as other Treasury, High Yield and Mortgage-backed debt bonds. The product’s nice blend of each type of bonds reduces interest rate risk.

Competition 

The fund is likely to face competition from other products in the Total Bond Market ETF space, which also provides exposure to a variety of public, investment-grade and taxable fixed income securities in the U. S.
Vanguard Total Bond Market ETF (BND) is likely to be the biggest competitor for this fund.

BND is the most popular product in this space with an asset base of $19.5 billion and an expense ratio of 10 basis points. However, unlike BYLD, the fund has a large exposure to U.S. treasuries (see all Total Bond Market ETFs here).

There are several other products as well in this space, such as, Vanguard Short-Term Bond ETF (BSV), Vanguard Intermediate-Term Bond Index Fund (BIV) and PIMCO Total Return ETF (BOND), all of which provide exposure to various bond types.

However, what differentiates BYLD from the rest is that the fund is not too heavily weighted towards government bonds or investment grade bonds. This feature also makes BYLD distinct from iShares Core Total U.S. Bond Market ETF (AGG), which also has the top exposure to Treasuries.

Nonetheless, the product’s rebalancing feature renders it slightly expensive from the rest, though the product’s nice mix of bond types might enable it to garner more assets over the long term.

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Read the analyst report on MBB

Read the analyst report on HYG

Read the analyst report on CIU

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