Reviewing The New Bond Sector ETFs

by on February 27, 2012 | ETFs Mentioned:

The innovation in the bond ETF arena just keeps on coming, as evidenced most recently by a trio of first-to-market products launched by iShares. Though there are more than two dozen ETFs in the Corporate Bonds ETFdb Category, until recently the level of granularity available from a sector perspective was rather limited. While investors can fine tune their effective duration, credit quality, and country exposure with fixed income ETFs, the options for targeting specific types of issuers had previously been non-existent. Bond ETFs generally cast a wide net from a sector perspective, including debt from various types of companies.

Earlier this month iShares rolled out three bond ETFs that focus on high quality corporate debt of companies in specific industries, including financials, industrials, and utilities:

  • iShares Financials Sector Bond Fund (MONY): The holdings of this ETF reads like a Who’s Who of Wall Street; companies such as Citigroup, Morgan Stanley, Goldman Sachs, Merrill Lynch, and Wells Fargo are among the issuing institutions.
  • iShares Industrials Sector Bond Fund (ENGN):┬áThis ETF includes debt of companies engaged in a wide range of industries; a sampling of component issuers includes AT&T, Anheuser Busch, Wal-Mart, Pepsi, and NBC Universal.
  • iShares Utilities Sector Bond Fund (AMPS):┬áThe issuers of the debt included in this ETF may not be as well known as those highlighted above; AMPS includes paper of companies such as Indiana Michigan Power, Xcel Energy, and DTE Energy.

Using Sector Bond ETFs

The holdings of MONY and AMLP probably don’t come as much of a surprise, but some may not have been expecting the degree of diversity offered by ENGN. Many of the issuers of the debt that makes up this ETF are not classified as industrials companies; AT&T is a telecom stock, while Anheuser Busch and Pepsi would fall into the consumer bucket. There are few similarities between the issuers of debt in ENGN and the stocks that make up the Industrials SPDR; XLI includes companies such as General Electric, Caterpillar, Boeing, and 3M. Other issuers in the industrial bond ETF include:

  • Kraft Foods (Consumer Staples)
  • Pfizer (Health Care)
  • Altria (Consumer Staples)

So ENGN can perhaps be thought of more accurately as an ex-financials ETF; the underlying portfolio consists of debt issued by companies in a number of lines of business, but is light on the financial sector [see the Better-Than-AGG ETFdb Portfolio].

Rounding Out Exposure

To understand the potential uses of these products, it is perhaps helpful to examine the composition if the iBoxx $ Investment Grade Corporate Bond Fund (LQD), which is the most popular ETF option for investors seeking exposure to high quality corporate debt. Just like any equity ETF, the holdings of this fund can be broken down by sector; LQD is heaviest in its allocation to financials (36%), consumer services (13%), and oil and gas (10%), but relatively light on its exposure to other sectors. Two of the segments targeted by the recent additions to the iShares lineup receive hardly any allocation in LQD; industrials make up only about 3%, while utilities account for less than 2% of the total portfolio.

The hefty weighting in LQD afforded to financial companies may be a bit disconcerting for some investors, especially considering the string of high profile bailouts and bankruptcies in this corner of the market over the past several years. ETFs such as ENGN and AMPS can be useful tools for achieving a more balanced corporate bond portfolio, eliminating sector concentrations that can potentially be problematic in turbulent environments.

Effective Duration 7.5 years 5.4 years 7.3 years 8.6 years
Yield To Maturity 3.6% 3.8% 3.1% 3.4%
Weighted Average Coupon 5.5% 5.3% 5.4% 5.6%

Perhaps not surprisingly, AMPS and ENGN both feature yields to maturity that are slightly lower than LQD, while MONY has a higher effective yield. So the utilities and industrials ETFs can be thought of as ways to both achieve a bit of diversification and lower overall risk by a bit–along with, of course, a commensurate reduction in expected yield. Just as ETFs that focus on utilities stocks have historically been effective tools for lowering overall volatility and smoothing performance, a utility-focused bond ETF such as AMPS can be used to take a bit of risk off the table.

These ETFs can be potentially very useful instruments for investors looking to fine tune fixed income exposure. Though those looking to keep their portfolios simple may find them too granular, it’s easy to see the appeal for those with very specific views on the fixed income market.

Disclosure: No positions at time of writing.