The year 2007 has seen an explosion in the number of fixed-income ETFs. In total, forty one new fixed income ETFs have come to market this year, from about six in past years.
iShares introduced thirteen fixed income ETFs in 2007 alone, bringing their total offerings to nineteen. And, two other potential heavyweights, Vanguard and SSgA, have entered the arena with a range of offerings: SSgA began selling eleven this year, and Vanguard five.
For SSgA, it is as if they have finally awakened from a thirteen-year sleep. They brought SPY, the $87 billion S&P equity gorilla, to the market in late January of 1993, and then largely sat back for the next decade and counted their chickens (to mix metaphors). But they are now counted among the fully awake, and 2007 has been a year of frenzied activity to this old-line money manager.
Vanguard, is, of course, a different story (they always are). They march to their own drummer, but their percussionist apparently found a new rhythm in 2007, and they decided to use their vast bond managing experience to stake their own claim in the fixed income ETF turf.
A couple of relative newcomers to the ETF market are also entering the fray. PowerShares, who has brought many imaginative equity ETFs to the market, is now selling seven fixed income ETFs. And, finally, Ameristock is offering five, all brought out this year.
So, what’s one to make of this surge in fixed income products? Once the dust settles, will they all be winners, or will their be some casualties? Here’s an end of year report card on about half the new entries than I cover. Next week I’ll take up to second half, which will include intermediates, long term and junk. International and munis are omitted from this analysis—perhaps at a later time.
First, let’s understand the difficulty of comparing un-like things. Not all bond funds are the same, and even those that may look similar, with similar metrics, may be different in other important ways. To bring some order to the potential chaos, I’m going to show first those ETFs that follow the exact same indices. That include the following three ETFs that are indexed to the Lehman Aggregate Bond Index, an intermediate term index that is often referred to as the total bond market index.
Lehman Aggregate Bond Index
*Yield is yield to maturity: current yield not available
AGG has over a five-year head start on its two cousins, so it is no surprise that it has accumulated over $7 billion in assets while the other two have yet to reach the billion dollar mark. Certainly Vanguard is growing much faster than its SSgA counterpart, reflecting, perhaps, the advantage Vanguard has in fixed income management.
The other point to note is that even at less than 10% of AGG’s assets, the Vanguard ETF has almost 20 times the number of bond holdings in its portfolio. This reflects two things: the Vanguard ETF is a “share-class” of Vanguard’s mutual fund that tracks the same index, with over $53 Billion in assets. The second reason is that Vanguard samples a huge percentage of an index. In the case of the Lehman Aggregate Bond Index, the index has a total of over 9000 names. Vanguard holds about one-third of that number.
Both SSgA and iShares employ much smaller samples to arrive at Lehman Aggregate Bond Index characteristics. On this point I would vote for Vanguard’s approach, since it should more closely track the actual index—there will be no sample error in its performance. But, this is probably a minor point over the years.
The expense ratios favor Vanguard slightly over SSgA, with iShares the more expensive of the three. This ranking order holds for most all fixed income funds these firms offer.
Another area where there are some exact pairs is in Treasury Inflation Protected Bonds. Both iShares and SSgA have ETFs that track the Lehman index for this type of debt. Table 2 details their characteristics.
Treasury Inflation Protected Bond ETFs
*These figures are “Effective Duration” rather than actual Average Duration. Since the future cash flows of TIPS are unknowable, depending on inflation levels, they are estimated—and, the estimates are likely wrong, but they do them anyway. The post-distribution average duration of TIPS funds and mortgage related funds is highly variable. You can’t have much confidence in the actual number since it is so volatile.
**Using yield to maturity since distribution data is not yet available for this ETF.
For short term bond holdings, there are no exact duplicates. Table 3 compares five ETFs that address this market.
There are varying credit and interest rate risks among these ETFs. iShares is all Treasury/Agency holdings, so their credit quality is AAA, but the inclusion of agency debt (Ginnie Maes, etc) makes for an unpredictable effective duration.
Vanguard’s BSV holds about 67%Treasury/Agency and 33% commercial, although the commercial debt is all investment grade. SSgA’s BIL is 100% Treasuries as is GKA, Ameristock’s entry.
Also of note, SSgA has a winner in BIL because of its ultrashort duration. It, and iShares’ SHV are closer to money market funds than any of the other short term instruments.
iShares has the big kahuna of short funds in SHY, with over $9 billion in assets—which shows the advantage of being the first mover in the ETF world.
Ameristock has not had success. Its basic creation unit is $2.5 million, and they have less than $100,000 over that amount since June of this year. I wouldn’t be surprised to see all Ameristock’s entries disappear by this time next year, but I hope I am wrong.
Don’t takes the yields as necessarily indicative of what to expect in the future or as a valid ranking. The dates of their computations are not necessarily the same. I would look for a closer correlation with duration/credit risks and dividend yield over the next year or so.
Overall, 2007 was a great year for fixed income investing, at least in the sense that we have many additional tools available this year. Also, one of the more interesting offerings, PowerShares laddered bond portfolio, gets my nomination for the most imaginative offering for the year, and one potentially quite useful. I’ll examine it more closely next week along with intermediate, long-term offerings and junk.