U.S. Total Bond ETFs A Good Balance For Volatility

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 |  Includes: AGG, BIV, BND, IEF, TIP, TLF, TLT
by: MyPlanIQ

“Total Bond” ETFs offer investors the opportunity to invest in a variety of bonds issued by both government and private players across the complete spectrum of maturities (short term to very long term). Consequently, total bond ETFs represent the average returns in the broader bond market and give long-term investors a low-risk investment option which helps hedge their debt portfolio against interest rate volatility.

The above-mentioned de-risking feature has made total bond ETFs very popular with investors and investment managers who handle retirement investments like IRA investments and 401K investments. Depending on the current interest rate scenario, total bond ETFs may underperform other debt market asset classes in the short-term but they generally have lower volatility and comparable long term returns.

Similarly, when we consider the performance of U.S. total bond ETFs vis-à-vis other asset classes, we find that they have significantly underperformed gold and various other intermediate and long term debt instruments. However, this short-term underperformance will surely reverse once global GDP growth picks up in the future. Let us take a close look at U.S. total bond ETF performance relative to other asset classes.

Major Asset Classes Trend, 11/14/2011

Description

Symbol

1 Week

4 Weeks

13 Weeks

26 Weeks

52 Weeks

Trend Score

Gold

GLD

-1.02%

6.51%

0.81%

19.14%

30.8%

11.25%

Intermediate Treasuries

IEF

0.11%

1.48%

2.67%

10.61%

10.96%

5.16%

Emerging Mkt Bonds

PCY

-0.32%

2.94%

1.91%

4.75%

5.55%

2.96%

Total US Bonds

BND

-0.37%

0.8%

1.08%

4.35%

6.47%

2.47%

US Stocks

VTI

-0.83%

4.69%

4.19%

-5.8%

7.44%

1.94%

US High Yield Bonds

JNK

-1.01%

2.62%

1.72%

-2.53%

6.23%

1.41%

Commodities

DBC

-1.94%

1.38%

-4.16%

-2.83%

10.08%

0.51%

International Treasury Bonds

BWX

-0.79%

-0.15%

-3.33%

0.83%

5.44%

0.4%

Emerging Market Stks

VWO

-2.77%

5.44%

-5.25%

-13.29%

-9.54%

-5.08%

International Developed Stks

EFA

-2.19%

-0.08%

-6.0%

-14.25%

-8.78%

-6.2

Click to enlarge

(For more information on the relative performance of various asset classes, see here.)

Fixed Income Assets Trend, 11/14/2011

Description

Symbol

1 Week

4 Weeks

13 Weeks

26 Weeks

52 Weeks

Trend Score

20+ Year Treasury

TLT

0.25%

1.64%

13.34%

25.17%

30.41%

14.16%

10-20Year Treasury

TLH

0.15%

1.53%

5.16%

14.78%

16.7%

7.66%

Inflation Protected

TIP

-0.65%

2.98%

1.78%

8.98%

12.86%

5.19%

Intermediate Treasury

IEF

0.11%

1.48%

2.67%

10.61%

10.96%

5.16%

California Muni

CMF

-0.04%

1.68%

2.12%

5.54%

10.41%

3.94%

National Muni

MUB

0.1%

0.87%

1.83%

4.52%

8.78%

3.22%

Emerging Mkt Bonds

PCY

-0.32%

2.94%

1.91%

4.75%

5.55%

2.96%

US Total Bond

BND

-0.37%

0.8%

1.08%

4.35%

6.47%

2.47%

Click to enlarge

(For more on the performance of various debt-based ETFs, see here.)

Now let us closely examine the most prominent and liquid U.S. total bond ETFs that are currently traded in the market.

U.S. Total Bonds, 11/11/2011

Description

Symbol

1-Year

3-Year

5-Year

Avg. Volume(NYSE:K)

1-Year Sharpe

Vanguard Total Bond Market ETF

BND

5.48%

7.4%

NA

1,530

185.33%

iShares Barclays Aggregate Bon

AGG

5.37%

8.06%

6.11%

1,127

184.41%

Vanguard Intermediate-Term Bon

BIV

5.33%

11.09%

NA

191

102.67%

PowerShares CEF Income Composi

PCEF

-1.99%

NA

NA

79

-20.53%

Click to enlarge

(For more information on ETFs representing various asset classes, see here.)

As we can see from the above table, both BND and AGG have relatively higher average volumes (1,530,000 and 1,127,000 respectively) and Sharpe ratios (185.33% and 184.41% respectively) making them both decent long term investment candidates. Since AGG has given consistent returns for over 5 years, let us consider its bond portfolio and risk profile in detail. AGG is structured to track the Barclays Capital U.S. Aggregate Bond Index and its top holdings mirror those of the index.

Top 10 Holdings (20.88% of Total Assets):

Company

% Assets

US Treasury Note 4.75%

3.69

US Treasury Bond 7.5%

2.61

US Treasury Note 3.625%

2.38

US Treasury Note 3.125%

2.31

US Treasury Bond 8.125%

1.92

FHLMC 4.5%

1.90

US Treasury Note 3.375%

1.88

US Treasury Bond 7.625%

1.51

US Treasury Bond 4.625%

1.46

US Treasury Note 2.375%

1.22

Click to enlarge

Bond Ratings (%)

Sector AGG Category Avg
US GOVERNMENT N/A N/A
AAA 3.53 N/A
AA 74.59 N/A
A 10.82 N/A
BBB 8.32 N/A
BB 0.28 N/A
B 0.00 N/A
BELOW B 0.00 N/A
OTHER 2.46 N/A
Click to enlarge

Maturity as of 11/10/2011

0-1 Years 4.39%
1-5 Years 30.65%
5-10 Years 21.54%
10-15 Years 4.57%
15-20 Years 2.18%
20-25 Years 6.50%
25 Years and Over 28.59%
Average 6.34 year
Click to enlarge

Looking at the data given above, we see that AGG holds various bonds including AA++ rated U.S. treasuries and mortgage backed securities in its portfolio. At the same time, these bonds are of different maturities with average portfolio maturity at 6.34 years. AGG’s top ten holdings solely comprise U.S. Treasury notes, and this helps stabilize the entire bond portfolio and reduces price volatility and credit risk.

At the same time, a significant chunk (over 30%) of AGG’s asset allocation is in various mortgage backed securities. This can lead to some unwanted price volatility given the current global economic situation. Alternately, U.S. treasury notes might start underperforming once global growth returns. Thus, with AGG we have a perfectly hedged bond portfolio where the underperformance of one core holding (MBSs) will be balanced by the out performance of the other (U.S. Treasury notes). This makes AGG a great U.S. total bond ETF for long term investment purposes.

Disclosure: I am long TLT.

Disclaimer: We do not have any business relationship with the company or companies mentioned in this article. We does not set up their retirement plans. The performance data of portfolios mentioned above are obtained through historical simulation, and are hypothetical.