Blackrock launches bond ETF to out-yield AGG
iShares is launching a smart beta bond ETFs that tries to give a bigger yield than the $88 billion iShares Core US Aggregate Bond ETF (AGG) while taking less interest rate risk.
The iShares USD Bond Factor ETF (USBF), which listed yesterday, will be self-indexed. It will draw bonds from the total US bond universe: from junk bonds, to treasuries, to rule 144As. Its central objective will be to provide a better risk-adjust yield than AGG.
The prospectus doesn’t fully reveal how specifically bonds are picked. But it mentions three strategies:
- Junk bonds picked based on momentum;
- Investment grade bonds picked based on highest yield with shortest duration;
- All bonds picked based on creditworthiness relative to their sector averages.
The final index built is designed to be as similar as possible to AGG in terms of risk, sector exposures, the types of bonds that it holds.
USBF charges 0.18%.
Analysis – more risk, more yield
There’s a lot going on in this ETF. The prospectus was slow going. Parts of it read like they were written by Immanuel Kant. Try the following 60-word sentence:
“The second step of the factor model is macroeconomic factor tilt, which assigns the Underlying Index’s allocation to predetermined maturity bands of the yield curve, specifically (1) long-maturity U.S. Treasury bonds and (2) short- and intermediate-maturity investment grade corporate bonds in seeking to maximize total return per unit of risk (defined as duration for U.S. Treasuries and DxS for corporate bonds).”
Looking at the portfolios on iShares website (here and here) we can see what’s going on. Whereas AGG gets almost 40% of its weight from treasuries, USBF goes in a lot harder on mortgage-backed securities (MBS) and corporate bonds. The net result is that USBF is taking more credit risks, which explains its higher yield.
While the credit risk of USBF is higher, the interest rate risk (duration) is lower. Which may be well timed for the current moment we find ourselves in.
In all, I like this ETF. It’s snazzy and sophisticated. I think it will take seed in the adviser market. Yield is hard to come by these days. And if this fund can find it without taking on more interest rate risk then there’s surely a place for it.