By Tyler Denholm, CFA, TOPS ETF Portfolios
Creating investment portfolios for accounts with stated investment restrictions, like endowments and foundations, presents some unique challenges which often do not occur with individual clients.
The primary concerns when creating portfolios for these investors are ensuring the portfolio abides by the investment objectives, asset allocation and any security holding constraints outlined in the investment policy statement (IPS).
For example, credit quality, type of issuer and duration are all fixed income characteristics where constraints may be given in an IPS. With over 300 available fixed income options, however, ETFs can be a very useful tool when crafting such precise portfolios.
One of the most common ways to segment a fixed income portfolio is by credit quality. Often, an IPS will eliminate or restrict the amount of non-investment grade bonds in a portfolio. With ETFs, it is relatively simple to fulfill this mandate. Most ETF providers offer an aggregate bond index ETF which invests solely in investment grade bonds.
Investment grade portfolios can be augmented by including a broad high yield holding (with behemoths being iShares iBoxx $ High Yield Corporate Bond ETF (HYG) or SPDR® Bloomberg Barclays High Yield Bond ETF (JNK) up to the prescribed limit defined in the IPS. By using these two transparent tools, managers can ensure appropriate and consistent exposure.
Portfolio managers looking to be more creative can overweight the higher quality credits within these spaces to help meet IPS thresholds. While there are several ways to accomplish over weights, iShares and Van Eck provide some straightforward solutions.
Within investment grade fixed income, there is the iShares Aaa-A Rated Corporate Bond ETF (QLTA), which strips out the BBB rated securities which are typically included in a broad investment grade ETF. For high yield bonds, VanEck’s Vectors Fallen Angel High Yield Bond ETF (ANGL) has almost twice the amount of BB exposure compared to most broad high yield ETFs.
Type of Issuer
Another area where ETFs can help portfolio managers in creating portfolios is by accessing specific issuers of fixed income. For example, some IPS documents may restrict the portfolio to only include sovereign issued debt. Available options in this instance would be any Treasury ETF or foreign debt that is sovereignly issued. Within Treasuries the largest broad market holding is the iShares U.S. Treasury Bond ETF (GOVT) with over $4B in AUM.
For foreign issuers of sovereign debt, one of the largest offerings is the SPDR® Bloomberg Barclays International Treasury Bond ETF (BWX) with over$1.5B in AUM. Likewise, if the IPS allows for agency issued debt alongside sovereign, there are multiple ETFs which can provide exposure to this specific space as well. These are only a few examples of the many ways to slice and dice the type of issuer.
A fixed income area where ETF issuers appear to have spent a majority of their focus is on the duration of the holdings. For practically every space mentioned in this article to this point, there are varying versions of maturity/duration available to help the portfolio manager fine tune the structure of the credit curve in their portfolio. Years ago, this targeted exposure was only able to be accomplished using individual bonds.
Outside of the traditional “short”, “Intermediate” or “long” breakdowns of the curve, there are some unique options such as FlexShares iBoxx 3 Year Target Duration TIPS Index Fund (TDTT) which targets a specific duration instead of a range of maturities. There is even interest rate hedged vehicles, such as ProShares Investment Grade-Interest Rate Hedged (IGHG), which use short US Treasury futures positions to offset the natural duration in the portfolio. Through a suite of funds from Guggenheim called BulletShares, a portfolio manager can purchase ETFs which only own bonds that mature in a specific year, such as 2020 or 2022.