While 2022 is not finished, two things are quite likely to be a fact in early 2023. We will have had the worst calendar year for the iShares Core Aggregate Bond ETF (AGG ) in its 19-year history, and approximately one thousand financial advisors coming to the Exchange conference in early February 2023 in Miami, Florida, will be looking for an alternative to the index-based ETF.
The popular core bond strategy declined 16% as of November 7, due in part to the negative impact of a hawkish Federal Reserve’s rate hikes that has pushed the yield on the 10-year Treasury bond sharply higher in 2022. Given AGG’s average duration of 6.3 years, the fund has suffered.
However, advisors are expected to maintain a healthy stake in fixed income in hopes of providing ballast and income to offset equity exposure. They typically attend ETF conferences like Exchange to learn about other tools available to help clients navigate the challenging bond market. The following strategies are worthy of consideration either as core replacements or to complement a broad market, index-based ETF, even as they charge higher fees than the 0.03% for AGG.
Actively managed core fixed income ETFs. The Fidelity Total Bond ETF (FBND ) and SPDR DoubleLine Total Return Tactical ETF (TOTL ) are examples of active ETFs that, as of November 7, had held up better than AGG. Actively managed ETFs can adjust duration to limit the impact of rising rates, to sort through the universe of new issuance to choose investment-grade bonds with strong risk-reward potential, and own speculative grade bonds that have low default risk. FBND and TOTL charge expense ratios of 0.36% and 0.55%, respectively.
Senior loan ETFs. The Invesco Senior Loan ETF (BKLN ) and SPDR Blackstone Senior Loan ETF (SRLN ) invest in securities not found within the investment-grade focused AGG. Senior loans are the unsecured claims against an issuer that receive priority in the event of bankruptcy and are typically rated below-investment grade. However, senior loans can help protect against interest-rate risk as they have an extremely short average of approximately three months. While BKLN tracks an index, SRLN is actively managed. Both ETFs declined significantly less than AGG thus far in 2022, even as BKLN and SRLN charge expense ratios of 0.65% and 0.70%, respectively.
Low duration investment-grade ETFs. The iShares 1-5 Year Investment Grade Corporate Bond ETF (IGSB ) and the PIMCO Enhanced Low Duration Active ETF (LDUR ) are more suitable alternatives for more risk-averse end clients than senior loan products. Both funds incur lower interest rate risk than AGG, with an average duration of under three years, but also hold investment-grade bonds. IGSB is index-based and concentrates on corporate bonds from issuers like Bank of America and CVS Health, while LDUR is actively managed and holds a mix of U.S government-related securities and credit. IGSB and LDUR charge fees of 0.06% and 0.53%, respectively.
The Federal Reserve may begin to shift its hawkish stance in early 2023 to let the U.S. economy attempt to reflect the successive rate hikes in the second half of 2022. While this would help AGG bounce back from the worst year, many investors will want something different in the fixed income sleeve of their portfolios for 2023. Advisors would be wise to learn more about the range of ETF products available with similar liquidity and ease of use. If they make it to the Exchange conference in February, there will be lots of smart people to learn from – maybe portfolio managers of these funds!
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