Ultimate ETF Income Guide: Bond ETFs

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1 Ultimate ETF Income Guide: Bond ETFs > By David and Michael Fabian At FMD Capital Management, our goal is to provide you with tools to enhance your income investing returns. With that goal in mind, we have created a series of special reports designed to give you succinct data along with tips to implement dividend paying ETFs into your portfolio. In conjunction with our multi-sleeve portfolio approach, these groups include: (1) dividend paying equities, (2) fixed-income and (3) alternative income solutions. In addition, to drown out the noise of thousands of available offerings, each sub-group will contain our carefully selected list of top ETFs to consider during varying market cycles. Each of these funds has been considerably researched according to our in-depth analysis process that includes index methodology, fees, tax efficiency, performance, volume, and risk. Bond funds may be the least exciting category of our three-sleeved portfolio, but also one of the most critical to get right as global central banks continue to tinker with interest rates and stimulus measures. This asset class includes numerous sector, duration, credit, tax exposure, and hedging options to incorporate in your portfolio. In addition, fixed-income plays a vital role in smoothing out the volatility of risk assets such as stocks and alternative income solutions. All told, there are nearly 300 ETFs dedicated to bonds in one form or another. In the following report, we break down our favorite ETFs in both the domestic and international space so that you have a handle on the best options available for your hard earned nest egg. Government Bond ETFs Government bond ETFs such as Treasuries, mortgage-backed securities, and other agency issues make up a tremendous amount of U.S. denominated debt. These funds typically have the highest sensitivity to interest rates because they exhibit a fundamental bias towards fluctuating bond yields. Most investors are probably familiar with high profile offerings such as the ishares 20+ Year Treasury Bond ETF (TLT) or the ishares TIPs Bond ETF (TIP). However, there are a whole host of alternative funds that can provide an attractive vehicle in a falling interest rate environment. One of our favorites is the Vanguard Intermediate-Term Government Bond ETF (VGIT), which combines a mix of Treasury and agency securities for better overall diversification and yield than a pure treasury alternative. In addition, this ETF charges a miniscule expense ratio of just 0.12% and has an overall duration near 5 years.

2 The following table encapsulates a list of our favored government bond ETFs (sorted by asset size). We prefer to use funds of this nature to provide tactical exposure to offset other credit positions in our portfolio or as a directional bet on falling interest rates. Ticker Fund Name Exp Ratio AUM ($M) Yield Duration TIP ishares TIPS Bond 0.20% $ 12, % IEF ishares 7-10 Year Treasury Bond 0.15% $ 8, % 7.78 SHY ishares 1-3 Year Treasury Bond 0.15% $ 8, % TLT ishares 20+ Year Treasury Bond 0.15% $ 7, % 18.5 MBB ishares MBS 0.27% $ 6, % IEI ishares 3-7 Year Treasury Bond 0.15% $ 5, % VTIP Vanguard Short-Term Inflation-Protected Securities 0.10% $ 1, % VGIT Vanguard Intermediate-Term Government Bond 0.12% $ % EDV Vanguard Extended Duration Treasury 0.12% $ % Corporate Bond ETFs Corporate bond ETFs are an interesting category because they encompass several sub-sectors including: investment grade, high yield (junk), convertible securities, and bank loans (floating rate notes). Each niche offers its own unique opportunities and risks given the prevailing interest rate and credit environments. The two most well-known funds in this space are the ishares Investment Grade Corporate Bond ETF (LQD) and ishares iboxx High Yield Corporate Bond ETF (HYG). As their names imply, these funds focus on the highest and lowest quality debt from a wide range of companies. The benefit to selecting a fund of this nature is that you get a high level of diversification, liquidity, and transparency in a very low-cost investment vehicle. For those that are concerned about the impact of rising interest rates, we have also included lesser known ETFs such as the ProShares Investment Grade - Interest Rate Hedged ETF (IGHG). This fund incorporates a traditional basket of bonds with short positions in U.S. Treasuries to reduce the impact of interest rates on the overall portfolio. There are also several short-duration options such as the PIMCO 0-5 Year High Yield Corporate Bond ETF (HYS) and Vanguard Short-Term Corporate Bond ETF (VCSH). We have written extensively about these ETFs as an alternative to lowering your interest rate exposure while still capturing modest yield as well. The following table (next page) encapsulates a list of our top-rated corporate bond ETFs (sorted by asset size). We prefer to use funds of this nature to enhance the yield on our Strategic Income portfolio in addition to significant capital appreciation potential in a supportive credit environment.

3 Ticker Fund Name Exp Ratio AUM ($M) Yield Duration ishares iboxx $ Investment Grade Corporate LQD Bond 0.15% $ 21, % 8.04 HYG ishares iboxx $ High Yield Corporate Bond 0.50% $ 16, % 4.16 JNK SPDR Barclays High Yield Bond 0.40% $ 10, % 4.43 CSJ ishares 1-3 Year Credit Bond 0.20% $ 10, % 1.88 VCSH Vanguard Short-Term Corporate Bond 0.12% $ 9, % 2.77 BKLN PowerShares Senior Loan 0.65% $ 5, % CWB SPDR Barclays Convertible Securities 0.40% $ 2, % HYS PIMCO 0-5 Year High Yield Corporate Bond 0.55% $ 2, % 2.14 VCLT Vanguard Long-Term Corporate Bond 0.12% $ 1, % HYHG ProShares High Yield - Interest Rate Hedged 0.50% $ % IGHG ProShares Invest Grade - Interest Rate Hedged 0.30% $ % International Bond ETFs International bond ETFs take many shapes and sizes, but the most sought after areas of the globe are typically in emerging markets. The ishares J.P. Morgan USD Emerging Market Bond ETF (EMB) and PowerShares Emerging Market Sovereign Debt Portfolio (PCY) are both excellent choices for enhancing the yield of your portfolio and diversifying overseas. Both ETFs currently sport yields near 5% and may offer a compelling argument for long-term capital appreciation as well. If you are seeking a more broad-based international bond fund, the Vanguard Total International Bond ETF (BNDX) may provide a suitable portfolio. This includes both developed and emerging market foreign nations, but has a much lower total yield. In addition, it s worth noting that currency trends can impact many of these funds as they are primarily priced in U.S. dollars. The ETFs marked as local currency are priced in the denomination of the host country or region. The following table encapsulates a list of our top-rated international bond ETFs (sorted by asset size). Ticker Fund Name Exp Ratio AUM ($M) Yield Duration EMB ishares J.P. Morgan USD Emerging Markets Bond 0.60% $ 4, % 7.22 BNDX Vanguard Total International Bond 0.20% $ 3, % 7.01 PCY PowerShares Emerging Markets Sovereign Debt 0.50% $ 2, % 9.45 BWX SPDR Barclays International Treasury Bond 0.50% $ 1, % 7.46 EMLC Market Vectors Emerging Market Local Currency Bond 0.47% $ 1, % 4.79 WIP SPDR DB Intl Government Inflation-Protected Bond 0.50% $ % ALD WisdomTree Asia Local Debt 0.55% $ % 4.18 PICB PowerShares International Corporate Bond 0.50% $ % 6.52 EMCB WisdomTree Emerging Markets Corporate Bond 0.60% $ % 6.09

4 Municipal Bond ETFs Municipal bond ETFs come with the added benefit of federal tax-free income and in some cases even state-specific tax benefits as well. These funds are often favorites for large taxable accounts that are looking for stable price action and steady monthly income. The ishares National AMT-Free Muni Bond ETF (MUB) is easily the largest ETF in this class with over $4 billion in total assets. This fund invests in a wide-array of municipal debt from several states around the country to create a highly diversified benchmark for this sector. If you are seeking a fund with more income potential, you may want to consider the Market Vectors High Yield Municipal ETF (HYD). This fund achieves its higher yield by investing in lower rated issuers and higher duration securities. However, it s always worth pointing out that high yield = high risk. Therefore, you should expect a consummate uptick on volatility with a fund of this nature versus MUB. We also included the largest offerings for California and New York on our municipal bond ETF list as well. These funds may allow for double tax-free status if you reside in the same state you are investing in. (Note: We recommend consulting a tax professional for your specific situation) The following table encapsulates a list of our top-rated municipal bond ETFs (sorted by asset size). We typically use ETFs of this variety for clients with larger taxable accounts that want to reduce a portion of their tax liability while still receiving a steady income stream. Ticker Fund Name Exp Ratio AUM ($M) Yield Duration MUB ishares National AMT-Free Muni Bond 0.25% $ 4, % 6.17 SHM SPDR Nuveen Barclays Short Term Municipal Bond 0.20% $ 2, % 2.90 HYD Market Vectors High-Yield Municipal 0.35% $ 1, % 8.79 TFI SPDR Nuveen Barclays Municipal Bond 0.23% $ 1, % 7.25 ITM Market Vectors Intermediate Municipal 0.24% $ % 7.08 SUB ishares Short-Term National AMT-Free Muni Bond 0.25% $ % 2.00 BAB PowerShares Build America Bond 0.28% $ % 9.05 HYMB SPDR Nuveen S&P High Yield Municipal Bond 0.45% $ % 8.96 CMF ishares California AMT-Free Muni Bond 0.25% $ % 6.67 NYF ishares New York AMT-Free Muni Bond 0.25% $ % 6.16 Total Return & Special Situation Bond ETFs Total return and special situation bond ETFs are generally more broadly diversified positions or actively managed strategies that can contain a number of different fixed-income profiles. While there are many suitable funds on this list, we also recommend benchmarking these core holdings against actively managed mutual funds as well. Several alternatives from PIMCO, Loomis Sayles, and DoubleLine have proven to beat these ETFs over time because of the managers expertise in security selection and risk management.

5 Picking a diversified bond fund to pair with dividend equity exposure is not an easy task considering the challenges facing fixed-income over the next several years. Ultra low yields around the globe have made the way forward a potentially treacherous one given the expectation of interest rate cycles changing over time. Despite the turmoil associated with its portfolio manager leaving last year, we still believe that the PIMCO Total Return ETF (BOND) is one of the leaders in this category. The pertinent factors for this decision include the fact it is one of the only truly global broad-market offerings in the ETF space with sufficient size and history. The newly established Fidelity Total Bond ETF (FBND) may be a suitable alternative as well, and should be closely watched as they develop the portfolio over time. Those investors seeking a more non-traditional route may be intrigued by the RiverFront Strategic Income ETF (RIGS), which is touted as a go anywhere, do anything style of actively managed fund. This gives the manager flexibility to shift their portfolio in response to changing interest rate and credit conditions. The following table encapsulates a list of our top-rated total return bond ETFs (sorted by asset size). We typically use ETFs of this style as core holdings to provide an appropriate level of income and low volatility for our portfolios. Ticker Fund Name Exp Ratio AUM ($M) Yield Duration BND Vanguard Total Bond Market 0.08% $ 26, % 5.21 AGG ishares Core U.S. Aggregate Bond 0.08% $ 23, % 5.23 BIV Vanguard Intermediate-Term Bond 0.10% $ 5, % 6.45 MINT PIMCO Enhanced Short Maturity Strategy 0.35% $ 3, % 0.35 BOND PIMCO Total Return 0.55% $ 2, % 4.43 GVI ishares Intermediate Government/Credit Bond 0.20% $ 1, % 3.83 RIGS RiverFront Strategic Income 0.22% $ % 3.30 LDUR PIMCO Low Duration 0.49% $ % 1.62 AGZD WisdomTree Barclays U.S. Agg Bond Zero Duration 0.23% $ % FBND Fidelity Total Bond 0.45% $ % 5.01 Conclusion Having both core and tactical exposure to fixed-income ETFs is an essential component of a balanced income portfolio. The funds we have listed above can be used to complement existing holdings, lower portfolio volatility, and enhance your returns over time. If you are looking to establish new holdings in these ETFs, we recommend doing so with smaller allocations that you can add to over time. In addition, it always makes sense to have a risk management plan in place to guard against any unforeseen events that may result in the decline of these securities.

6 For clients in our Strategic Income Portfolio, we can allocate up to 70% of the portfolio into these assets when conditions indicate a favorable risk-to-reward opportunity. Success requires planning, and planning for success is what we do at FMD Capital Management. We are a fee-only wealth management firm that helps clients achieve their goals by providing a clear investment plan and implementing it decisively. We pride ourselves on providing our income clients with open communication and a structured risk management approach to minimize volatility whenever possible. Contact us today at or visit to request a free portfolio analysis or help constructing an income portfolio to meet your needs. The information expressed by FMD Capital Management is for informational purposes only and should not be construed as a recommendation to buy, sell, or hold any specific security. Investing involves the risk of loss and further risk disclosure can be obtained by reading the ETF or mutual fund s prospectus. FMD Capital Management clients may own securities mentioned in this report. P.S. To learn more about the favored fixed-income ETFs and actively managed mutual fund themes we are currently implementing for clients in our Strategic Income portfolio, simply call our offices at