Investors looking for core fixed income exposure have plenty of options to consider in the world of ETFs. One of the more compelling members of that group is the FlexShares Core Select Bond Fund (NYSEArca: BNDC), which is an alternative to strategies linked to the widely followed d Bloomberg Barclays Aggregate Bond Index.
BNDC looks to provide attractive risk-adjusted performance by investing in a portfolio of fixed-income securities and is designed to achieve the optimal potential for return, according to the prospectus. Moreover, the active component will adjust to potential changes in interest rate levels, the shape of the yield curve and credit spread relationships while emphasizing liquidity and diversification.
Many investors simply focus on duration and yield when examining bond ETFs, but there are other factors to consider, including weighted average option-adjusted spread.
“A bond’s option-adjusted spread is the difference between its yield and the current risk-free rates (typically US Treasury rates), adjusting for any embedded options,” according to FlexShares research. “For a fixed income ETF, the weighted average option-adjusted spread is calculated by weighting the option-adjusted spreads of the underlying bonds by their market value in the portfolio.
A bond ETF’s weighted average option-adjusted spread measures the credit risk of its option-embedded bonds. This is possible because the metric removes the embedded options, thereby isolating the option for analysis.”
Digging Deeper
BNDC looks to provide attractive risk-adjusted performance by investing in a portfolio of fixed-income securities and is designed to achieve the optimal potential for return, according to the prospectus. Moreover, the active component will adjust to potential changes in interest rate levels, the shape of the yield curve and credit spread relationships while emphasizing liquidity and diversification.
Another factor bond ETF should evaluate is weighted average maturity (WAM).
“A bond’s maturity date is the date on which the bond issuer agrees to repay the investor the original sum owed—also known as the principal amount,” according to FlexShares. “For a fixed income ETF, Weighted Average Maturity (WAM) is calculated using each bond’s maturity date weighted by its market value in the portfolio. The higher the WAM, the longer it may take for all of the bonds in the ETF to mature.”
In addition to Treasuries and corporate bonds, BNDC has exposure to mortgage-backed securities (MBS).
MBS are created when an entity acquires a bundle of mortgages and then sells the securities. Most MBS are seen as “pass-through” security where the principal and interest payments are passed through the issuer to the investor.
While MBS may offer modestly higher yields relative to U.S. Treasuries, the mortgage-backed bonds are exposed to prepayment risk – if rates dip before the security’s maturity, a homeowner can refinance debt, causing an investor to get back the principal early and reinvest it in a security with a lower yield.
For more on multi-asset strategies, please visit our Multi-Asset 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.