Fresk: iShares ‘Core’ Means New Exposures

June 19, 2014

An important differentiating factor is the yield advantage offered by the Universal index over the Aggregate. As of June 16, this equated to a nearly 30 basis points of yield advantage for the Universal index. The trade-off for this yield advantage is a riskier portfolio due to the inclusion of high-yield debt and a potentially less liquid portfolio because of 144A bonds.

Based on the cost structure, IUSB allows an advisor to capture this “additional” exposure at a very reasonable cost. Breaking down the exposure to an aggregate and “nonaggregate” view, the additional exposure costs about 50 basis points in expense ratio:

  • Aggregate: 83 percent of IUSB costing 8 basis points (using the iShares U.S. Aggregate Bond ETF (AGG | A-97) as a proxy)
  • Nonaggregate: 17 percent of IUSB costing 50 basis points
  • Combining those two factors, I arrive at IUSB’s 15 basis point expense ratio

This additional cost seems inexpensive for the exposure captured.

After all, accessing high-yield debt using the iShares iBoxx $ High Yield Corporate Bond ETF (HYG | B-69) costs 50 basis points; and getting at developing markets debt via the iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB |B-50) costs 60 basis points.

Apart from the attractive cost considerations, there’s the additional fact that using a fund with a “Universal” index can capture other exposure not currently available in ETF form; namely, eurodollar, 144A and non-ERISA CMBS.

Taking a long-term view over the past 20 years on a total return aspect, the Universal index has outperformed the Aggregate index by 0.20 basis points per year, or a return of 6.34 percent versus 6.14 percent.

Universal_Vs_Aggregate_Returns

The index changes on these two existing funds, ISTB and ILTB, will also have an effect of broadening the exposure as compared with the previous exposure. Both ETFs previously tracked government/credit indexes. As such, securitized exposure was excluded from each.

For ISTB, the new index will now include MBS exposure with original maturities of 15 years or less. This is in addition to the aforementioned exposure that falls within the shorter maturity band. According to Barclays, this securitized exposure makes up about 14 percent of the index. This additional exposure will differentiate ISTB from other short-term bond ETFs, such as the Vanguard Short Term Bond (BSV | A-68).

For ILTB—the long-term debt ETF—the main differential will be the addition of the aforementioned exposure that falls in the 10+ year maturity band. However, this index doesn’t include securitized bonds, which are limited to the shorter maturity indexes based on their duration profile.

 

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