Deconstruct the Aggregate Bond Index with Fixed Income ETFs
This article was originally published on ETFTrends.com.
The iShares Core US Aggregate Bond ETF (AGG) , which tracks the investment results of the Bloomberg Barclays U.S. Aggregate Bond Index, can give bond investors general exposure to the fixed income markets, but there are times when current market conditions warrant a deconstruction of the AGG to extract maximum investor benefit.
The deconstruction of the AGG refers to an investment strategy in which an investor corners a specific portion of the bond market sectors--Government debt via Treasuries, agencies, credit, mortgage-backed securities (MBS), commercial mortgage-backed securities (CMBS), and asset-backed securities (ABS). It would be akin to a real estate investor focusing on only one portion of a residential investment property, such as the kitchen after upgrades are planned or the backyard prior to installing a pool.
Relative to the fixed income market, deconstructing the AGG will allow exposure to sectors where markets are higher yielding, sometimes in lieu of accepting more risks. Market experts, such as Jordan Farris, Managing Director of ETF Product Development at Nuveen, view the deconstruction of the AGG as a viable investment strategy.
Nuveen offers investment solutions in fixed income ETFs, such as its NuShares Enhanced Yield US Aggt Bd ETF (NUAG) that tracks the the ICE BofAML Enhanced Yield US Broad Bond Index.
"Investors are in need of income and the majority of traditional aggregate bond indices weight by issuance as opposed to something more aligned with client objectives," said Farris. "In the case of NUAG, we track an index that weights the underlying index constituents by yield within a set of predetermined risk parameters."
Related: The Fed Needs to Focus on the Treasury Yield Curve
While its difficult to mitigate risk in all types of market scenarios, deconstructing the AGG could serve has hedge plays in the market stemming from short-term interest rate changes.
"Since launch in September of 2016, NUAG has realized superior returns due to the unique weighting methodology," Farris told ETF Trends. "It will not outperform in all market scenarios, but our research shows that this type of strategy has generally outperformed over full market cycles. It has the added benefit of delivering an outcome to investors--increased income--that is needed and relevant at this point in time."
Being flexible in the current fixed income environment can certainly be a boon, particularly when yield curves on government debt, such as the 10-year Treasury, have been relatively flat as of late. With investor appetites getting skewed towards a more risk-on approach, delving into higher yields like those offered by corporate bonds is an alternative strategy.
Related: Nuveen Rolls Out Socially Responsible Bond ETF
"The increase in exposure to Treasuries in addition to generally lengthening duration since the credit crisis has weighed on performance," said Farris. "In contrast, NUAG currently allocates more weight to investment grade corporate bonds and securitized credit offering enhanced yield without significantly extending duration."
With the second half of 2018 in full swing, it will be interesting to see how the bond markets respond to an economic environment where higher interest rates are abound. If the economic data is conducive to more rounds of interest rate spikes by the Federal Reserve, deconstructing the general bond market could be necessary strategy rather than an option.
For more fixed income strategies, visit the Fixed Income Channel.
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