For many investors, the Barclays U.S. Aggregate Bond Index serves as the most recognized benchmark for fixed income returns. However, in the low-interest rate environment of recent years, investors have increasingly looked outside the Agg to supplement income in meeting their investment goals.
In doing so, they introduce additional risks and different sources of volatility that need to be carefully understood. In response, WisdomTree collaborated with Barclays to create a rules-based index—the Barclays U.S. Aggregate Enhanced Yield Index (Agg Enhanced Yield)—that broadly retains the risk characteristics of the Agg while enhancing the income potential of the portfolio.
Enhancing Income Potential of the Agg
Yield can typically be increased by shifting exposure along any of a number of risk dimensions, including sector exposure (Treasury, agency, credit, securitized), interest rate risk (duration) and credit risk.
The Agg Enhanced Yield uses a rules-based approach to reallocate across 20 distinct subcomponents in the Agg, seeking to enhance yield while maintaining a similar risk profile. This strategy allows an investor to focus on the investment-grade credit universe, without having to dip into the high-yield segment of the market to enhance yield potential.
Yield and Duration Comparison, June 30, 2015
As we show above, the Agg provides a variety of opportunities for income across various sectors and interest rate risk profiles.
• Across the yield curve, debt guaranteed by the U.S. government tends to have the lowest levels of yield per unit of interest rate risk.
• Next, securitized debt or bonds backed by a pool of receivables such as mortgages can provide a modest lift in yield in exchange for the slightly higher probability that the borrower may default.
• Finally, investment-grade credit can provide an additional increase in yield compared to credit risk-free Treasury debt. In our view, many investors may fail to realize that the Agg could provide greater opportunities for return once they take a closer look at the individual components.
However, if investors simply allocated based on yield, the portfolio would be significantly over-weight credit and interest rate risk. In our view, this naïve approach to fixed income does little to enhance an investor’s prospects for return.
Through our approach to the Agg, when a variety of constraints focused on risk management are applied, the output of the Index methodology resulted in a portfolio with an additional 75 basis points (bps) of income potential, while retaining a similar interest rate risk profile to that of the Barclays Agg.1 This incremental yield advantage is typically achieved through increased exposure to corporate and securitized debt and reduced exposure to U.S. Treasury securities. The implementation of relative sector and quality constraints, however, also helps the Index preserve the diversification potential of a broad-based, core fixed income strategy.
There’s an Exchange-Traded Fund for That
With the launch of the WisdomTree Barclays U.S. Aggregate Bond Enhanced Yield Fund (AGGY) on July 9, 2015 WisdomTree packaged this unique approach in an exchange-traded fund (ETF). AGGY is listed on the New York Stock Exchange with a net expense ratio of just 12 bps.2 By searching for income within the investment-grade universe, AGGY could represent a step forward for investors looking to generate greater income potential while broadly retaining the risk characteristics of familiar core fixed income portfolios.
1Source: Barclays, as of 6/30/15. Income potential comparison based on the yield to maturity of the Barclays U.S. Aggregate Index and the Barclays U.S. Aggregate Enhanced Yield Index.
2Gross expense ratio 0.20%. The net expense ratio reflects a contractual waiver of 0.08% through 12/31/16. Ordinary brokerage commissions apply.