Another way to Build your Fixed Income Portfolio

In today’s interest rate landscape, the search for yield can be a difficult pursuit, particularly when you consider that yields on traditional core bond funds are less than half of what they were in 2008.1 With the Fed and other central banks maintaining low interest rates with accommodative interest rate policies, investors are finding it harder and harder to meet yield and income targets.

As my colleague Russ Koesterich points out, the prolonged period of low rates is forcing many investors to enter into more speculative fixed income asset classes. Many investors have traditionally targeted a 5% yield for their fixed income portfolio, but to get that today you likely need to invest in high yield, emerging markets, or other higher risk asset classes. These investments may not suit the needs of every investor, and if they do, investors are often unsure of how much to allocate or how to blend them into the rest of their fixed income portfolio.

It seems low yields are here to stay for now, as the Federal Reserve’s latest minutes reinforced that it intends to keep rates “low for long”. That’s why it’s especially important to have a well-diversified portfolio of investments at the center of your portfolio, one that includes a fixed income allocation that is structured towards yield, but is also mindful of risk.

With this in mind, we just introduced the new iShares Yield Optimized Bond ETF (BYLD). This fund is benchmarked to the Morningstar US Bond Market Yield Optimized Index. This Morningstar 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.

BYLD itself is a fund of funds; the fund will generally hold assets in the securities of the underlying Morningstar index.2 It thus provides exposure to a range of iShares funds in a single ticker, with weighted allocations to U.S. Treasuries, TIPS and agency bonds, plus investment grade corporate and floating rate bonds, as well as high yield and mortgage-backed debt.

The Morningstar index rebalances each quarter, and BYLD is anticipated to rebalance along with it. This means that the holdings of the fund should adjust over time in response to changes in market conditions. Some investors may recognize that BYLD is in some ways a cousin to the iShares Multi-Asset Income ETF (IYLD). IYLD also tracks a yield optimized Morningstar index, but one that invests in a range of asset classes across both fixed income and equities.

Here are the BYLD holdings as of 4/24/2014:

So why are we launching BYLD? Really, it’s in response to a question that I get a lot from investors: “With the growing number of fixed income ETFs in the market, how do I put them together to create a portfolio?” Of course, the answer depends on what role you see fixed income playing in your portfolio, but for investors who are looking for a way to seek more income within the foundation of their fixed income allocation, BYLD may be a good fit. It provides diversification across a number of individual iShares funds, has a holdings tilt that is focused on yield, and is designed to deliver risk that is consistent with the broader fixed income market, all in a single ticker.

For more on the fixed income sectors we like, including tax-exempt bonds, see Russ K’s latest Investment Directions monthly market commentary.