A Credible Alternative to Traditional Bond Funds

The number of fixed income exchange traded funds eschewing weighting by market capitalization in favor of alternative or fundamental weighting methodologies is on the rise. One of the more seasoned options in that group is the WisdomTree Barclays U.S. Aggregate Bond Enhanced Yield Fund (NYSEArca: AGGY), which is nearly three and a half years old.

The fund 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.

Many traditional aggregate bond funds, including ETFs, are heavily allocated to U.S. Treasuries and other forms of government debt. That strategy can hinder investors’ ability to get adequate income out of these funds while also introducing the specter of sensitivity to rising interest rates.

“The strategy offers higher yield by tilting toward corporate bonds and away from U.S. Treasuries relative to the Aggregate Index,” said Morningstar in a note out Friday. “Although it takes greater credit risk than its parent benchmark, this risk is moderate and is more representative of how active managers in the intermediate-term bond Morningstar Category invest.”

A Higher Yield

Currently, AGGY’s 30-day SEC yield is 3.82%, or 56 basis points above the comparable yield on the Bloomberg Barclays US Aggregate Bond Index. AGGY’s yield is higher than the benchmark due in part to the fund tilting toward corporate bonds and away from low-yielding Treasuries.

“As of this writing, the fund allocates half of its portfolio to corporate bonds compared with 30% for the Aggregate Index,” according to WisdomTree. “Conversely, its Treasury weighting measures about 20% of the portfolio compared with the Aggregate Index’s 40%. Securitized assets make up the remaining portion of the fund’s holdings, in line with the Aggregate Index’s weighting.”