How To Outperform The Barclays Agg

Fidelity’s O’Neil tells us how his strategy is delivering the goods in a time marked by uncertainty.

Reviewed by: Cinthia Murphy
Edited by: Cinthia Murphy

There are four actively managed total return bond ETFs on the market today, each seeking to outperform the Bloomberg Barclays US Agg, iShares Core U.S. Aggregate Bond ETF (AGG), while offering investors a nimble, tactical approach to fixed-income investing.

The funds, which include the SPDR DoubleLine Total Return Tactical ETF (TOTL), the PIMCO Total Return Active ETF (BOND), the Guggenheim Total Return Bond ETF (GTO) and the Fidelity Total Bond ETF (FBND), command a combined $5.6 billion in assets. This year, the most impressive performance among them is in FBND, which happens to be one of the smaller of these funds, with $208 million in assets. 


Chart courtesy of


Ford O’Neil manages FBND as well as Fidelity’s mutual fund version of this strategy, and he tell us what has worked thus far this year, as well as what’s changed following the outcome of the presidential election. Fixed-income ETFs have been hugely popular this year. As of the end of October, U.S. fixed-income ETFs had more than $71 billion in net creations in 2016, not only more than U.S. equity ETFs have gathered this year, but about 40% of all ETF asset flows we've seen year-to-date. What's been driving this surge in demand for fixed-income exposure?

Ford O'Neil: One thing we've seen since the global financial crisis is people better understanding the value of having fixed income in their overall portfolios. It sometimes takes an equity market drop of over 20 or 30% to remind people why they need fixed income.

Income's an important component here. When money market funds and bank CDs are earning next to nothing, that’s critical. Preservation of capital's also important, and there's much better preservation of capital in fixed income relative to other more volatile securities. Lastly, there are the benefits of diversification. Broadly speaking, that’s why fixed income has done well.

The other key big secular theme is demographic trends. As baby boomers continue to retire, they're slowly shifting from equities to fixed income. That, from our perspective, will be impacting fixed-income flows for years to come. From a performance perspective, though, November hasn’t been easy. Is there an election-related unwinding of the massive run-in to things like AGG, LQD (iShares iBoxx $ Investment Grade Corporate Bond ETF) and TLT (iShares 20+ Year Treasury Bond ETF), or is there something else at play here?

O'Neil: Longer-term bond returns have been in the mid- to high-single-digits for several years now. And we've been cautioning clients in the last few years that their expectations for returns should be much more modest: low- to mid-single digits, at best. That's important, and remains unchanged.

Now there's always a certain level of uncertainty in any market, and that’s increased in the past two weeks. Most expected a divided House/Senate/White House, and eight more years of gridlock.

The two tail events that existed were a Democratic sweep or a Republican sweep, the latter being the one offering the highest level of uncertainty today. But markets at this point are speculating on what might occur over the next four years—there are few facts to go on.

When we think about investing, we think about bonds and securities with a time horizon of one to two years, on average. So it's much harder for us to speculate on what's driving markets week to week. Shorter term, if we see higher interest rates beginning in December, possible tax cuts and a pickup in inflation, as many predict, should we expect investor demand to shift out of long-dated Treasurys and into TIPS and shorter-term debt?

O’Neil: The Federal Reserve will increase the fund rates rate by 25 basis points in December. But if you look at market expectations for 2017 and 2018, the market today is only anticipating three rate increases over that next two-year period. That’s very modest.

More of the reaction we’ve seen from the market is in the 10- and 30-year portion of the curve. Its term premium is rising because of the uncertainty. But, yes, we like TIPS a lot relative to nominal Treasurys; but we've liked them for all of 2016.

The breakevens on TIPS were below 1.5% at the beginning of this year. We felt that was unsustainable. We didn't know when inflation might actually come back. We felt that pressure was building in the pipeline, especially on the wage side.

We were confident we were going to see inflation at some point in time, but it's come fairly quickly in the last two weeks. You've seen a fairly significant increase in Treasury inflation-protected breakevens over that time period. We own nominal Treasurys in the portfolio, but we think TIPS are also something you should have in your portfolio. FBND is one of four actively managed total return bond ETFs on the market today. And so far in 2016, it’s outperformed its peers by at least 2 percentage points. What's behind this outperformance?

O'Neil: There are really two factors. On one hand, we feel that the Federal Reserve is no longer in the QE business. At the same time, Treasury yields remain quite low, and agency mortgage-backed security spreads remain quite tight relative to history.

Both sectors will revert to historical norms over the coming years. That could take two or three years. So we feel both of those government guaranteed sectors are not attractive relative to other opportunities in the marketplace.

In underweighting those sectors, we also overweighted TIPS. Our TIPS position is about 6% in the fund. We also have a material overweight to credit. That credit is both in the investment-grade and in the noninvestment-grade areas. Both are attractive.

We also liked the commercial mortgage-backed securities market, the CMBS market and emerging markets. And we have a little bit in taxable munis.

We have a couple hundred investment professionals in our fixed-income group continually turning over rocks and coming up with great ideas across the entire spectrum of fixed income.

We've got hundreds of securities in the portfolio that we think are really attractive that will have similar risk profiles to that of the benchmark, but much better return profiles. And by having small overweights in all those different sectors, and picking good securities, we’ve seen material outperformance relative to the benchmark. In the high-yield bond segment, we’ve seen spreads decline relative to Treasurys significantly this year, from something like 8-9% in January to 4-4.5% now. What do you do in terms of exposure to high yield going forward?

O'Neil: We've had three wonderful opportunities to buy high-yield securities in the past eight years—2009 was the best; 2011 was also very attractive; and the beginning of this year.

If you look at the eight-year period since the financial crisis, the vast majority of time, high-yield securities have traded between 400 and 600 basis points over Treasurys. And today they're about 500 bps. They've come a long way since February, but they’re still in the middle of the range of their historical norms.

Today high yield is not a sector you should be adding to, but at the same time, if you're able to avoid defaults and not own securities that are downgraded in that sector, there's still a lot of room for security selection to outperform.

If I can buy high-yield securities in the 6.5-7% yield range, and the Barclays Agg today is at 2.5%, there's an awful lot of yield advantage relative to this sector if you get the security selection right. But you have to get it right. How has the election changed your outlook for, or your positions in, these segments?

O'Neil: The election has increased the uncertainty in the marketplace. And I'm not today feeling that the U.S. economy will be materially stronger in 2017, unlike those folks who are claiming that reduced regulation, large infrastructure program, and materially lower corporate and individual taxes will lead to a much stronger economy. Were all to come to pass, I would agree with that. But I'm not convinced we're going to get everything currently on the table.

Part of my skepticism today is that Republicans have been fairly straightforward about their view with regard to austerity over the past six years, and debt ceilings and deficits. Some pundits are claiming of all of this could double or triple the deficit of this country if they were to get everything they wanted. I'm not necessarily sure that's what’s going to get passed.

On the flip side, people will strongly argue that the other two tenets of the campaign—immigration and trade—are net/net negative for our economy over the long term. It's almost like we're—at least in the short term—pricing in all the good news and not really pricing in any of the bad news. It’s unclear to me in what direction we will truly go. Is this a case for active management in fixed income—being able to quickly react and adjust in the face of uncertainty? I’m sure you’d say yes.

O'Neil: Yes. One thing we feel very strongly about is the importance of flexibility when you think about a fixed-income portfolio in the current environment of low rates and, in some cases, low spreads. The ability for the portfolio manager to react on a day-to-day basis to opportunities they see across the entire globe is key.

Contact Cinthia Murphy at [email protected]


Cinthia Murphy is head of digital experience, advocating for the user in all that does. She previously served as managing editor and writer for, specializing in ETF content and multimedia. Cinthia’s experience includes time at Dow Jones and former BridgeNews, covering commodity futures markets in Chicago and Brazil equities in Sao Paulo. She has a bachelor’s degree in journalism from the University of Missouri-Columbia.