AGG iShares Core US Aggregate Bond

While equity ETFs have led the way in terms of development so far, bond products are finally beginning to catch up to their stock brethren. 2011 saw the debut of a host of bond ETFs including funds that track broad emerging markets, China, and various developed nation fixed income segments as well. While all of these were welcomed additions to the ETF lineup, one product in particular seemed to be an extremely intriguing way to play the broad space, the Madrona Global Bond ETF (FWDB) from AdvisorShares.

FWDB: Global Bond ETF In Focus

FWDB launched in May of 2011 and is pretty unique among bond ETFs that are on the market today. The product doesn’t track a benchmark but instead looks to exceed the price and yield performance of its benchmark, the Barclays Capital Aggregate bond Index which is the basis for many popular funds such as AGG or BND. The fund managers hope to achieve this by selecting a diversified portfolio of fixed income exchange-traded products without regard to sector or geography. In fact, the fund promises to invest in at least 12 distinct global bond classes that cover the entire global investable bond universe (read Go Local With Emerging Market Bond ETFs).

This is accomplished by using two techniques based on the shape of the yield curve and where the managers believe it will go in the future. Yield curve analysis on a class by class basis is employed in order to determine which section of the curve is most suitable for investment at this current time, hopefully allocating to the segment that has the best chance of outperformance. Furthermore, analysts will also look at how the current curve compares to historical averages in order to invest in products that could gain if bonds revert to the mean. This strategy could help keep bonds well diversified across asset classes and push investors into a fixed income portfolio that could outperform over the long term.

Currently, the product is heavy in investment grade corporates which constitute one-fourth of the portfolio although mortgage-backed securities and high yield American corporate bonds comprise 14% and 13% of the portfolio, respectively. Beyond these sectors, U.S. short-term government debt makes up about 7% of the total holdings while a smattering of sectors—10 in total—make up at least 3% of the portfolio as well (see Top Three High Yield Junk Bond ETFs).

For this exposure, investors do have to pay a higher fee than other bond ETFs in the space as the net operating expense ratio comes in at 1.15% thanks to acquired fund fees and various other expenses. While this might not sound like a lot compared to many mutual funds, it is in fact close to ten times higher than what AGG charges to investors. In part due to this high cost, the product isn’t the most liquid or popular among investors as it trades about 10,000 shares a day and has AUM below $16 million, suggesting that relatively wide bid ask spreads may be waiting for some investors (see ETFs vs. Mutual Funds).

Since the fund’s inception, however, it has slightly underperformed AGG from a performance perspective. Although it is worth pointing out that the fund doesn’t exactly have a long track record and that FWDB has outgained AGG by about 30 basis points in the past three month period. Additionally, the yield on FWDB is far greater than what AGG is paying out, suggesting that for those looking for higher payouts but are still wary of taking on more risk, the fund could be an ideal choice (read German Bond ETFs In Focus).

This could especially be true if a bear market hits American Treasury bonds in the near future. AGG has close to one third of its assets in American T-Bonds and doesn’t offer up any allocations to TIPS or international securities giving it a heavy focus on U.S. finances. On the other hand, FWDB has a much more reasonable 16% of its assets in the U.S. government bond sector and has assets that are far more spread out both in terms of sector and geographic representation (also read Can You Fight Inflation With This Real Return ETF?).

As a result, FWDB could be the best bond ETF for investors seeking broad allocations to the market over the long-term. Don’t be fooled by the fund’s short-term underperformance; the techniques involved in the construction of the fund are sound and could offer up a better way to play the sector for most investors. So if turmoil strikes American bonds in the near future or if foreign securities and corporates are able to outperform in 2012, investors will likely be glad they cycled into this more diversified, but often overlooked bond ETF for their fixed income exposure.

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