Tag Archives: etf

Summary The expense ratio on AGG is one of the drawing factors for this fund. At .08% it is one of the cheapest bond funds in the market. The fund has extensive diversification in the maturity of the bonds which provides more diversification in the risk. The credit ratings are fairly high with a significant allocation to treasury securities. Allocation to MBS does not thrill me since mREITs are available at material discounts to book value, but the low expense ratio still helps the expected return. Overall, there is more to like about this fund than to dislike. The major risk factor facing the fund is rising domestic rates. The iShares Core Total U.S. Bond Market ETF (NYSEARCA: AGG ) is a highly diversified bond fund with a reasonable yield, great expense ratio, and great liquidity. Expenses When I’m looking for a bond ETF, I normally want to see diversification in the holdings. The only real exception would be if I’m looking for treasuries with a fairly steady maturity date. Getting any thorough due diligence on the bonds in a fund can require having a higher expense ratio to cover the costs of doing research. The challenge for a bond fund with a high expense ratio to create solid returns is that it requires them to be doing sufficient research to consistently produce superior default estimates to those available in the market or to have a method for acquiring bonds at a discount by dealing in illiquid bonds where counterparties are more difficult to find. Some funds are able to offer low expense ratios and mitigate their risks by strictly dealing in the most liquid bonds where pricing is most likely to be efficient and relying on the market to ensure that the risk/return profile is appropriate. Generally I favor ETFs that have low expense ratios and strictly deal in highly liquid bonds where the pricing will be more efficient. The expense ratio for AGG is a .08%. This is one of the funds falls into my desired strategy of using highly liquid securities and a very low expense ratio to rely on the efficient market to assist in creating fair values for the bonds. Yield The yield is 2.41%. The desire for a higher yield should be fairly easy for investors to understand. Bond funds that offer a higher yield are offering more income to the investor. Unfortunately, returns are generally compensating for risk so higher yield funds will usually require an investor either take on duration risk or credit risk. In many situations, an investor will take on a mix of the two. Junk bond funds generally carry a high degree of credit risk but low duration risk while longer duration AAA corporate funds have only slight to moderate credit risk combined with a significant amount of duration risk. Theoretically treasuries have zero credit risk and long duration treasuries would have their risk solely based on the interest rate risk. Duration The following chart demonstrates the sector exposure for this bond fund: At the present time I’m concerned about taking on duration risk in early December because of the pending FOMC (Federal Open Market Committee) meeting. I believe it is more likely than not that we will see the first rate hike in December. I think a substantial portion of that probability has already been priced into bonds, so investors willing to take the risk prior to the meeting could see significant gains if the Federal Reserve does not act. Even though most of the impact is priced in, I suspect it will happen and that there will be some impact on rates which may trigger a solid opportunity for starting investments in bonds. I’ll be looking to increase my positions in interest sensitive assets if rates move higher. I’ve been focused on bond funds that are free to trade for me or have a longer duration exposure to corporate debt, but AGG is a pretty solid option for investors looking to add bonds in December. Credit Risk The following chart demonstrates the credit exposure for this bond fund: The exceptionally high rating to triple AAA stocks includes positions in treasury securities. The very high credit rating of this fund is excellent for investors looking for something that can withstand a sharp decline in the equity market. Rather than declining with equity markets this bond fund should see strength in share prices when investors are scared about the risk of higher defaults and weaker equity performance. When things look ugly, this fund should perform well. When things look great, this fund should underperform some of the riskier options. Sectors The following chart demonstrates the sector exposure for this bond fund: I have some concerns about the sector allocation including a substantial allocation to MBS Pass-Through securities. There are several mREITs where investors can get MBS exposure at a substantial discount to book value. On the other hand, that exposure also includes exposure to hedging the portfolio with Eurodollar Futures contracts in most scenarios and the expenses of management for an mREIT will dramatically exceed the .08% expense ratio of holding AGG. Conclusion Overall the diversification here is pretty solid and I don’t see much to complain about. This is one of the largest bond funds on the market and it offers great liquidity, a decent but not incredible yield, and a very low expense ratio. That liquidity extends to the point of millions of shares trading in a single day. That keeps the bid-ask spread small and makes trading in and out the ETF much easier for investors that want to use it to stabilize their portfolio value.