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Shifting Bond Exposures

Todd Rosenbluth

Quick question: For bond exposure, is it best to invest in an ETF that tracks the Bloomberg Barclays U.S. Aggregate Bond Index or to buy different ETFs that track different segments of the broad bond index (and, potentially, over- or underweight them according to existing market forces)?

This was a topic of much debate at a panel during the Wealth/Stack conference earlier in September (at which CFRA was a featured presenter alongside Dave Nadig of ETF.com and others). Fellow panelists highlighted how active managers have had success outperforming the popular bond index (much more so than active equity managers succeed in outperforming the broad equity market indices).

Indeed, the 10-year annualized total return for the average Lipper core bond fund of 4.6% as of August 2019 was higher than the index’s 3.9%. However, at the conference, we spent little time discussing how the exposure the “AGG” provides has shifted in the past decade.

Rising Risk

Yet understanding what’s inside the index (and any ETFs that track it) is crucially important. Indeed, when reviewing bond funds, CFRA believes investors should assess the interest rate risk, as measured in years by duration, and credit risk they incur. These risk factors are offset by the fund’s yield.

At the end of 2008, the index then known as the Barclays U.S. Aggregate Bond Index had average duration of 3.7 years and had a 7% weighting in credit rated BBB, the lowest possible ratings level for the investment-grade-focused benchmark.

Fast-forward to June 2019: The duration for the index had extended by more than 50% to 5.7 years, and the weighting in BBB bonds rose to 14%. Despite this elevated risk, the yield the index provided decreased to 2.5% from 4.0%.

 

How Has the AGG’s Risk/Return Profile Shifted?

Source: PIMCO

 

For a larger view, please click on the image above.

Shifting Bond Market

The bond market has changed in recent years due to new issuance, and adjustments in the risk that investors collectively are willing to incur for stable income. The iShares Core U.S. Aggregate Bond ETF (AGG), which tracks the Bloomberg Barclays Aggregate Bond Index, has changed too, reflecting the changes to the underlying index. Meanwhile, advisors looking for higher income or less risk have a variety of ETF tools at their disposal.

For examples, bond ETF investors could choose to shorten their duration (versus AGG) using the iShares Core 1-5 Year USD Bond ETF (ISTB) or the Vanguard Short-Term Bond ETF (BSV), each which has an average duration of less than three years and yet also focuses solely on the investment-grade universe of bonds.

Beyond Investment Grade

Or, if in search of higher yield than offered by AGG, investors could look into the VanEck Vectors Fallen Angel High Yield Bond ETF (ANGL), which sports a 5.2% 30-day SEC yield. ANGL invests primarily in bonds rated BB that were previously part of the investment-grade universe but were downgraded to junk status. Many active and index-based funds must remove securities that are no longer rated BBB or higher, which can at times create attractive valuations. More traditional high-yield bond ETFs such as the iShares iBoxx USD High Yield Corporate Bond ETF (HYG) and the SPDR Bloomberg Barclays High Yield Bond ETF (JNK) might also fit the bill, providing exposure to securities rated BB and B.

Lastly, rather than managing their bond ETF lineup individually, they could use one or more of the growing number of actively managed bond ETFs available. These include the Fidelity Total Bond ETF (FBND), the PIMCO Active Bond ETF (BOND) and the SPDR DoubleLine Total Return Tactical (TOTL). These funds are positioned differently from one another, warranting scrutiny, but they also currently incur less duration than AGG.

For those investors wanting to learn more about the last group of funds, CFRA will be hosting an ETF webinar on Sept. 24 at 11 a.m. ET: “Understanding Active Fixed Income ETFs.” To register for this event, visit https://go.cfraresearch.com/Active-Fixed-Income-ETFs.

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