The Bloomberg Barclays U.S. Aggregate Index is one of the most widely followed bond benchmarks in the world and home to more than 7,700 bonds, it implies some level of diversity. However, upon closer examination, the “agg” is heavily allocated to the U.S. government.

While that limits credit risk, it also limits investors’ income-generating potential. Yield has been hard to come by as of late and with more yield comes the prospect of taking on more risk via duration.

“Treasury bonds are among the safest assets because they are backed by the full faith and credit of the U.S. government,” said Morningstar in a recent note. “That said, risk and return are often highly correlated in the fixed-income market. While the increase in the Aggregate Index’s allocation to Treasury bonds has decreased risk, it has also decreased yield. Moreover, the benchmark has become increasingly less representative of how actively managed core bond funds construct their portfolios.”

A compelling alternative to standard “agg” ETFs is the WisdomTree Barclays U.S. Aggregate Bond Enhanced Yield Fund (NYSEArca: AGGY).

AGGY Over Easy

AGGY uses a“rules-based approach and re-weights the subcomponents of the Bloomberg Barclays U.S. Aggregate Bond Index to enhance yield, while broadly maintaining familiar risk characteristics. AGGY tries to boost return by reweighting the components of the Aggregate Index. But this additional yield is not free as it comes with greater credit risk and rate risk,” according to WisdomTree.

The $1 billion AGGY has an effective duration of 6.62 years and a 30-day SEC yield of 2.63%. The WisdomTree fund breaks the agg index into 20 components and uses an optimizer not found on traditional bond funds to boost yield.

“The 20 components are defined by sector and years until maturity. The sectors include government (Treasury and agency bonds), credit (split along the lines of credit ratings), and securitized,” according to Mornngstar. “There are three distinct maturity buckets: long (greater than 10 years), medium (five to 10 years), and short (one to five years). Constraints are applied to ensure the fund does not deviate too far from the Aggregate Index. For example, the index’s duration must be within one year of the Aggregate Index’s. Also, the weight of each sector is bound to stay within either 20% (for Treasuries, credit, and securitized bonds) or 10% (for agency bonds) of the Aggregate Index’s weighting to each.”

Investors have added $578.20 million to AGGY this year.

For more on smart beta ETFs, visit our Smart Beta Channel.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

AGFIQ WEBCAST

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