Don’t Assume US Bond ETFs Are US Focused

July 16, 2014

 

Allocation 2 And Comparison To Allocation 1
Fund Allocation % % Intl Bond Intl Bond Exposure
iSharse US Credit Bond ETF 60% 30% 18%
Allocation 2 Bond Portfolio 60% 30% 18%
Allocation 1 Bond Portfolio 60% 15%

These sample allocations are meant to serve as examples. Actual holdings may differ.

Some of the ETFs and indexes include “U.S.” in their title, so it may be very easy for investors to overlook the shift in their country allocation that is occurring.

Many investors may assume selling the iShares 1-3 Year Treasury Bond ETF (SHY | A-97) and buying an ETF that tracks the Barclays U.S. 1-3 Year Credit Bond Index (CSJ) we mentioned above involves very little change in the country allocation. Instead, more than 40 percent of the assets in CSJ are backed by firms outside the U.S.

The debt included in the ETFs above is often dollar-denominated, but it depends on the ETF. One risk for financial planners is that investors will discover their international bond allocation is much greater than they expected or desired. An international corporate bankruptcy or the sudden decline in the euro may show up directly in the price of these ETFs.

The third allocation challenge is that some of the active ETFs can take on large allocations to specific countries. The Pimco Low Duration ETF currently has a 12 percent allocation to South Korean bonds.

That makes South Korea the second-largest country allocation after the United States. That seems like a large allocation for a country that only makes up 2.02 percent of the Vanguard Total International Bond Index Fund (BNDX | B-46).

Users of the actively managed funds will have to pay attention to expected country allocations and anticipate that weights will change with opportunities.

Solutions

Are there any potential solutions?

The PowerShares Fundamental Investment Grade Bond Portfolio (PFIG | B-75) offers the best alternative to the international bond allocation challenge. As part of its index design, the $26 million ETF excludes foreign agencies, governments and supranationals.

All issuers must be domiciled in the United States. (Table 1 shows Morningstar identifies only 1.26 percent of the bonds as outside the U.S., most likely due to differences in the classification of a small number of issuers.)

While the main selling point of PFIG is its fundamental weighting methodology, it also appears to offer the most domestically focused bond available. Hopefully, some of the ETF providers will look at an index that invests in the U.S. only. Until then, I believe PFIG is your best choice for keeping your bond allocation close to home.


CLS Investments is an Omaha, Neb.-based third-party investment manager and ETF strategist. CLS began to emphasize ETFs in individual investor portfolios in 2002, and is now one of the largest active money managers using exchange-traded funds, with more than $2 billion invested. Contact CLS’ Chief Investment Strategist Scott Kubie at 402-896-7406 or at [email protected]. Please click here for a complete list of relevant disclosures and definitions.



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