Fixed-income investors who are seeking a more all-inclusive bond exchange traded fund strategy should look beyond those that track the traditionally monitored aggregate bond index.
For instance, the iShares Core Total USD Bond Market ETF (NYSEArca: IUSB) tries to reflect the performance of the Barclays U.S. Universal Bond Index.
“Using an index fund that tracks the Universal Index, such as IUSB, can help investors reduce the total number of index funds and ETFs they need to either benchmark or gain exposure to the total bond market,” according to Morningstar analyst Thomas Boccellari.
The Barclays U.S. Universal Bond Index is seen as a parent index to the popular Barclays US Aggregate Bond Index. Along with including exposure to everything in the Aggregate Index, the Universal Index holds high-yield corporate debt, and eurodollar, emerging-markets, 144A securities and commercial mortgage-backed bonds that are excluded from the Aggregate Index.
IUSB includes U.S. dollar-denominated bonds rated either investment- or speculative-grade. Looking under the hood, the ETF includes AAA-rated bonds 61.0%, AA 4.2%, A 12.1%, BBB 13.0%, BB 3.7%, B 3.3% and CCC 1.1%.
In contrast, something like the iShares Core U.S. Aggregate Bond ETF (NYSEArca: AGG), which tracks the Barclays US Aggregate Bond Index, focuses on investment-grade debt, with a 72.7% tilt toward AAA-rated debt, 3.5% to AA, 11.6% to A and 12.4% to BBB. [Big Money Loves Fixed Income ETFs]
Consequently, Boccellari argues that an investor with an Aggregate Bond Index ETF would have to bolster his or her exposure to high-yield debt through a junk bond ETF. Alternatively, an investor would no longer need an additional speculative-grade bond ETF with the more inclusive IUSB.
“Owning a fund that tracks the Universal Index can limit the costs of rebalancing other bond fund holdings to ensure that no individual sector weighting becomes too big relative to other sectors,” Boccellari added.
Additionally, due to its exposure to higher-yielding assets, IUSB comes with a slightly higher 2.08% 30-day SEC yield, compared to AGG’s 1.77% 30-day SEC yield. Both funds also come with similar durations – IUSB has a 5.09 year duration and AGG has a 5.2 year duration.
Due to its greater tilt toward riskier assets, IUSB can underperform AGG during periods of market stress. During the slowdown and corporate bond problems in the late 1990s and early 2000s, the Universal Index underperformed the Aggregate Index. The Universal Index also lagged behind its subindex during the 2008 financial crisis. Nevertheless, both indices generated positive returns during volatile markets, and the Universal Index has shown historically better risk-adjusted returns across various market cycles.
However, fixed-income investors would still have to supplement their portfolios with tax-exempt municipal bonds and Treasury inflation-protected securities, which are both excluded from the Universal and Aggregate Indices. [Muni ETFs Are a Good Alternative in Low-Yield Environment]
For more information on the fixed-income market, visit our bond ETFs category.
Max Chen contributed to this article.