Due to their weighting methodology, aggregate bond exchange traded funds have increasingly accumulated a larger tilt toward U.S. Treasuries. As rates begin to rise, ETFs with heavier positions in higher duration Treasury bonds could begin to lag other fund strategies.
Aggregate bond ETFs, or funds with broad bond exposure, are weighted by market capitalization, so issuers with the largest amount of cumulative debt outstanding have a larger weight in the index.
Ever since the turn of the millennium, the U.S. government has issued more debt at a faster pace than corporations in order to pay for the expanding federal deficit, writes Morningstar analyst Thomas Boccellari. Consequently, the percentage of U.S. Treasuries in the Aggregate Bond Index has jumped to 40% from 16%.
For instance, the Vanguard Total Bond Market ETF (NYSEArca: BND) has a 42% weight in Treasury/Agency bonds and iShares Core U.S. Aggregate Bond ETF (NYSEArca: AGG) includes 36.7% in Treasuries. AGG tracks the Barclays Aggregate Bond Index, and BND follows the Barclays U.S. Aggregate Float Adjusted Index, which excludes mortgage-backed bonds held on the government’s balance sheet.
The heavier position to Treasuries has helped funds like BND and AGG to outperform during periods of duress due to their large exposure to safe-haven Treasuries.
“The index’s lower risk profile could help when investors need it the most,” Boccellari said.