SPDR ETFs’ Bartolini encourages investors to look beyond “Agg”

Jun 16th, 2017 | By | Category: Fixed Income

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Investors looking for US broad aggregate fixed income exposure may wish to look beyond ETFs tracking the Bloomberg Barclays US Aggregate Bond Index (“Agg”), according to Matthew Bartolini, head of SPDR Americas research at SSGA.

Matthew Bartolini, head of SPDR Americas research at SSGA.

Matthew Bartolini, head of SPDR Americas research at SSGA.

Mutual funds and ETFs linked to the index’s performance have been the traditional default option for investors looking for a broad vanilla bond exposure and collectively attracted $21 billion of inflows last year.

The iShares Core US Aggregate Bond ETF (NYSE: AGG), for instance, has swelled to $46bn in assets.

Bartolini believes, however, that a significant portion of these assets are misplaced. He argues that the Agg no longer efficiently captures the broad market exposure it was designed to reflect.

Bartolini’s first specific concern is that the index has become overly tilted toward Treasuries. He says: “Although the Agg has always had an implicit Treasury tilt, the tilt has been amplified since the 2008 financial crisis. The Agg now carries a near-perfect correlation to the Bloomberg Barclays US Treasury Index and may not offer the diversification investors are looking for.”

Treasuries are by far the largest sector allocation at 37.0%. Mortgage-backed securities also make up a sizeable chunk of the total, with 28.2%, followed by corporate – industrials (15.6%) and corporate – financials (7.9%). The graph below sets out the changes to sector allocations within the index over time.

Source: SPDR ETFs.

Bartolini also believes the seemingly stellar historic performance of the Agg may lure investors into a misguided sense of security. He argues that Agg’s yield matters greatly as a contributing component of future total return.  As of the end of May, the yield to worst on the Agg was 2.5%, a level Bartolini believes is likely too low to meet investors’ portfolio objectives. The Agg’s current yield is 2.9%.

Finally, Bartolini highlights that the risk characteristics of the index have shifted from its historical levels to reflect lower return, but higher risk. See graph below.

Source: SPDR ETFs.

He says: “The Agg’s high concentration of government holdings greatly increases its interest rate risk. As the Agg’s duration has spiked, its yield has plummeted, thus, investors are accepting less return for a higher amount of risk.” The effective duration of the index is currently 5.9 years.

According to Bartolini: “The Agg is skewed to antiquated fixed income segments that concentrate risk, sector exposure and their low rates can be a drag on performance. These characteristics are a bigger hazard now, thanks to the continued desire for stable streams of reliable income amid a backdrop of low rates, US government gridlock, policy uncertainty and general geopolitical instability.”

For those looking to move beyond the Agg, Bartolini is still a fan of the indexing approach but recommends building a better bond bucket by striking a balance by using ETFs that seek to provide targeted exposure to credit, duration and market segments.

SPDR ETFs offers a range of Treasury, municipal, US investment-grade and high-yield corporate bond funds, targeting various maturity segments across the yields curve.  The firm also offers a broad mortgage-backed bond ETF. Investors may wish to use components of this suite to construct a broad market bond exposure with risk and return characteristics tailored to the individual’s preference.

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