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Inside the New Vident Core U.S. Bond Strategy ETF (VBND)

Zacks Equity Research

The bond ETF space and the likely rise in short-term interest rates next year have become hot topics of discussion in the U.S. market. Investors are busy analyzing what type of duration and investment grade bonds should be the best pick at present especially given faltering global growth, strengthening of the U.S. economy, Fed outlook and Ebola concerns (read: 3 Overlooked Bond ETFs Holding Up in The Market Slump).

In such a backdrop, fund issuer Vident Financial launched a bond ETF in mid October in the name of Core U.S. Bond Strategy ETF (VBND). Let’s dig a little deeper into the fund and find out the pros and cons of this approach, as well as long-term viability of the product in detail:

VBND in Focus

The newly launched product looks to track the Vident Core U.S. Bond Strategy Index, which is composed of U.S. fixed income securities that collectively seek to deliver current income. The ETF is a set of U.S. treasuries, agency securities, mortgage-backed securities, investment-grade corporate bonds, high-yield corporate bonds and TIPS, per the prospectus

The ETF has moderate interest rate risk as the portfolio is spread out among securities with different maturities. Around 21% of its assets are occupied by securities with 3–5 years of maturity followed by the securities with 5–7 years that have around 18% exposure. However, the fund has some longer term bond exposure as well. Long-term bonds with 7–10 years of maturity take about 12% of exposure while more than 43% goes to 10+ bonds.

The credit quality of the portfolio looks to skew towards higher quality, though the fund looks to employ a variety of diversification tactics to spread risk around as well. In total, the fund has about 71 bonds, while it will charge 45 bps in fees a year for the exposure.

How Does it Fit in a Portfolio?
The recently launched fund could be an attractive solution for investors given the potential of rising interest rates. The Fed has decided to wrap up its bond buying program this October. Though the Fed reaffirmed to keep the rates low for longer, speculations are rife that it will start raising rates by next year. In fact, a flurry of upbeat economic numbers in recent times has raised speculation about an earlier-than-expected rate hike.

Though a still sluggish global economic backdrop might force the Fed to hike short-term rates later than expected, the step will most likely be taken relatively soon.  Moreover, the Fed has noted that the rate hikes will be steeper when it is initiated (read: 3 Ultra Safe Bond ETFs to Dodge Market Turmoil).

Investors should note that since a hike will be focused on the short end of the yield curve, short-term bond ETFs will likely be the most vulnerable next year. On the other hand, long-term bonds always carry high interest rate risks while short-duration ones are of the opposite nature.  Thus, a spread out approach toward the yield spectrum with a heavy focus on long-term bonds might satisfy investors need at the current level.

Can it Succeed?

The product has already started to taste success having generated about $79.6 million in assets within just a few weeks of its launch. Its total bond market approach with a tilt toward long-term bonds made it a winner.
The product operates in the total bond market category. The space is presently topped by billion-dollar funds Vanguard Total Bond Market ETF (BND) and iShares Core U.S. Aggregate Bond ETF (AGG) (read: Will Retirement ETFs Fall Out Of Favor with Investors?).

AGG typically invests in a variety of fixed income securities which are issued by various government agencies, as well as corporates, and maturity-wise, the product is less inclined to long-term bonds. On the other hand, BND is suitable for medium- to long-term investors being in the same operating vertical with newly launched VBND.

Apart from these two, there are innumerable funds available in the total bond market space, with each product having a unique proposition regarding investment grade, effective duration and expense ratio. So, in the long run the competition should be tough for VBND.

However, given the uncertainty over interest rates, the fund might be able to attract more inflows as investors seek to protect their bond portfolios from volatility.  Thus, at the current level, the product should be on solid footing as the broader market and expected interest policy should gel nicely with the fund’s investment objective. 

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