Morningstar ETF Clone Resorts to Managed Bond Funds

by: MyPlanIQ

We are in the process of trying to replicate the performance of the Morningstar 401K plan with ETFs. We identified two weaknesses in the ETF portfolio -- international equity and fixed income. In the last article we dealt with the international equity portion and in this article we deal with fixed income.

We reviewed performance for each of the funds that are coupled together by sub-class type.

Ticker Name 5 year AR (%) 3 year AR (%) 1 year AR (%) ETF Score Mu Fund Score
JNK SPDR Barclays Capital High Yield Bond 4.15 6.89 11.89 35%
PHIYX PIMCO High Yield Instl 5.51 6.10 7.11 33%
PRRIX PIMCO Real Return Instl 5.40 4.34 5.44 28%
TIP iShares Barclays TIPS Bond 4.10 2.46 4.06 20%
AGG iShares Barclays Aggregate Bond 5.28 5.05 3.76 27%
PTTRX PIMCO Total Return Instl 8.07 8.64 6.61 44%
GVI iShares Barclays Interm Govt/Credit 5.47 5.11 13%
LSBDX Loomis Sayles Bond Instl 6.35 4.82 8.32 35%
PRWBX STABLEVALUE 3.96 3.07 (0.21) 16%
SHY iShares Barclays 1-3 Year Treasury 3.65 1.99 1.07 15%
BSV Vanguard Short-Term Bond ETF 1.08 0.90 3%
VBISX Vanguard Short-Term Bond Index Inv 4.36 2.87 0.10 17%

We can see that in the fixed income sub-classes, the high yield bonds (JNK and PHIYX) and short term treasury (SHY, PRWBX) run neck and neck. There is a fair gap in the inflation protected bonds (TIP and PRRIX) but the biggest gaps are in the short term bonds (BSV, VBISX), intermediate bonds (AGG, PTTRX) and multi-sector bonds (GVI, LSBDX).

We will look at these last three biggest culprits.

If we consider short term bonds, the problem is that the ETFs are all very new. It might be worth swappin in VCSH going forward but there just isn't enough history yet so this is a watching brief to see how they perform:

Ticker Name 5 year AR (%) 3 year AR (%) 1 year AR (%) Score
VBISX Vanguard Short-Term Bond Index Inv 4.4% 2.9% 0.1% 17%
CSJ iShares Barclays 1-3 Year Cred 3.2% 2.1% 7%
VCSH Vanguard Short-Term Corp Bd Id 3.7% 4%
SCPB SPDR Barclays Capital Short Term 3.0% 3%

If we now look at the multi-sector bonds:

Ticker Name 5 year AR (%) 3 year AR (%) 1 year AR (%) Score
LSBDX Loomis Sayles Bond Instl 6.4% 4.8% 8.3% 34.6%
AGG iShares Barclays Aggregate Bon 5.3% 5.3% 3.8% 27.7%
BND Vanguard Total Bond Market ETF 2.0% 2.3% 5.3%
BIV Vanguard Intermediate-Term Bon 2.4% 3.8% 7.5%
PCEF PowerShares Income Composite 9.7% 9.7%

We are again plagued with short histories and AGG performs reasonably well -- however AGG is used to match PTTRX. Some of the newer ETFs may give better alternatives in future but there is nothing that closes the gap.

PTTRX has been a staple in many portfolios and has continued to do an outstanding job of delivering consistently high returns. Again, the ETF selections lack much history although there are some promising alternatives.

Ticker Name 5 year AR (%) 3 year AR (%) 1 year AR (%) Score
PTTRX PIMCO Total Return Instl 8.1% 8.6% 6.6% 44%
ITR SPDR Barclays Cap Interm Term 6.2% 6%
VCIT Vanguard Interm-Tm Corp Bd Idx 7.7% 8%
CFT iShares Barclays Credit Bond 5.1% 5.5% 13%
CIU iShares Barclays Intermediate 4.8% 4.8% 12%
CORP PIMCO Investment Grade Corp Bd 0%

Given this background, we decided to insert the retail version of PTTRX and LSBDX -- PTTDX and LSBRX and deal with the additional fees and redemption periods. We can go back and further optimize the other fixed income but this was a big enough change that we thought we would see how it turned out.

Performance chart (as of Feb 28, 2011)

Performance table (as of Feb 28, 2011)

We can see that the addition of the managed bond funds does give us a point or two of additional returns. It is important to note that this is slightly higher during the downturn when fixed income becomes even more of a focus.

If we now compare this with the original Morningstar portfolio, we can see that we have closed the gap to a large degree. Remember that the ETFs are newer and so the simulation can only put the money into cash when the ETFs don't exist.

Performance chart (as of Mar 1, 2011)

Performance table (as of Mar 1, 2011)

Portfolio Name
1Yr AR 1Yr Sharpe 3Yr AR 3Yr Sharpe 5Yr AR 5Yr Sharpe
Morningstar 401K ETF Clone-PID-PIZ-LSBRX-PTTDX Tactical Asset Allocation Moderate 15% 124% 11% 88% 14% 95%
Morningstar 401K ETF Clone-PID-PIZ-LSBRX-PTTDX Strategic Asset Allocation Moderate 15% 153% 3% 16% 6% 33%
Morningstar Inc 401K Plan Tactical Asset Allocation Moderate 21% 168% 12% 121% 14% 125%
Morningstar Inc 401K Plan Strategic Asset Allocation Moderate 13% 178% 3% 22% 5% 35%

We notice that the original portfolio has performed better with TAA in the short term but over the longer time horizons, the performances are much closer.

There is a danger that this is considered returns chasing -- that we are building a portfolio based on history and not forward looking and there is some justification to that charge. In particular, more attention could be given to some of the newer fixed income ETFs as they build history. A reasonable middle ground seems to be to either add the new funds and allow styles rotation to bring them in when merited or to wait another year and see what the historical trail looks like.

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

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.