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While listening to my favorite investment shows talk about the Fed’s decision this week on interest rates, it made me want to discuss why we need to continue to passively own bonds of all sorts. At my firm Ortner Capital, we are very optimistic about what the asset class has done for investors, and what they will continue to do. Let’s discuss quickly two outcomes this year that are being talked about and why they will continue to benefit long-term bonds.
First off, if the Fed eases rates due to the market pressures, long-end bonds should continue to increase in value. Secondly, if the Fed sees an urge to lower the discount rate this year, the bond market should continue to get a bid due to investors wanting less risky assets. As of writing, there is no talk of higher rates in the short-term. This can show you how quickly interest rate conditions can change from year-to-year.
After reading this article, I would like the reader to feel an urge to invest a core position in the iShares Core Aggregate Bond Index ETF (AGG).
The Investment Objective
The iShares Core U.S. Aggregate Bond ETF seeks to track the investment results of an index composed of the total U.S. investment-grade bond market. AGG offers a low-cost and easy way to diversify a portfolio using fixed income while seeking stability and pursuing income. It invests across a wide range of securities, from investment grade and public to fixed income. It does not include junk bonds or tax-free municipals.
Barclays Aggregate Returns
Year-to-date, the AGG has returned an impressive +5.23% return, while only half way through the year. Investors should note this is an equity like return without taking equity like risk.
Data by YCharts
(Source: YCharts.com)
As you can see from the above chart, AGG has had a positive price trend this year. Looking at the next six months, I can’t see a dramatic change in this trend. If rates were to head higher and the equity markets logged in even more highs, then we could see a lower AGG price. Lets take a longer-term view at the annual returns for Barclays Aggregate Index table below:
| Year | Barclays Agg. | Difference vs. S&P 500 |
| 1980 | 2.71% | -29.79% |
| 1981 | 6.26% | +11.18% |
| 1982 | 32.65% | +11.10% |
| 1983 | 8.19% | -14.37% |
| 1984 | 15.15% | +8.88% |
| 1985 | 22.13% | -9.60% |
| 1986 | 15.30% | -3.37% |
| 1987 | 2.75% | -2.50% |
| 1988 | 7.89% | -8.72% |
| 1989 | 14.53% | -17.16% |
| 1990 | 8.96% | +12.07% |
| 1991 | 16.00% | -14.47% |
| 1992 | 7.40% | -0.22% |
| 1993 | 9.75% | -0.33% |
| 1994 | -2.92% | -4.34% |
| 1995 | 18.46% | -19.12% |
| 1996 | 3.64% | -19.32% |
| 1997 | 9.64% | -23.72% |
| 1998 | 8.70% | -19.88% |
| 1999 | -0.82% | -21.86% |
| 2000 | 11.63% | +20.74% |
| 2001 | 8.43% | +20.32% |
| 2002 | 10.26% | +32.36% |
| 2003 | 4.10% | -24.58% |
| 2004 | 4.34% | -6.54% |
| 2005 | 2.43% | -2.48% |
| 2006 | 4.33% | -11.46% |
| 2007 | 6.97% | +1.48% |
| 2008 | 5.24% | +42.24% |
| 2009 | 5.93% | -20.53% |
| 2010 | 6.54% | -8.52% |
| 2011 | 7.84% | +5.73% |
| 2012 | 4.22% | -11.78% |
| 2013 | -2.02% | -34.31% |
| 2014 | 5.97% | -7.49% |
| 2015 | 0.55% | -0.70% |
| 2016 | 2.65% | -9.35% |
| 2017 | 3.54% | -18.16% |
During this time period as interest rates trended lower, the Barclays Aggregate Bond Index returned an impressive 7.87% annually. With its highest returning year in 1982 at +32.6%, and lowest returning year down -2.92% in 1992, it’s easy to see the reward is higher than the risk. Again, this is without owning any equity-like securities.
AGG Asset Allocation
When looking at an ETF, you should always take a look at what the fund actually owns. Let’s take a look and see what sectors of the bond market it currently owns, as the index is constantly changing:
|
Treasury |
39.85% |
|
MBS Pass-Through |
26.87% |
|
Industrial |
15.33% |
|
Financial Institutions |
8.13% |
|
Agency |
2.32% |
|
CMBS |
1.97% |
|
Utility |
1.84% |
|
Supranational |
1.19% |
|
Sovereign |
1.01% |
|
Local Authority |
0.82% |
(Source: ishares.com)
AGG Risk Metrics
I always read over carefully with clients at my practice the risk metrics of any fund or investment. Even though this is a pure passive ETF that is tracking a large index, one must still go over these metrics. Let’s take a quick look at the most important metrics below:
| Arithmetic Mean (monthly) | 0.33% |
|---|---|
| Arithmetic Mean (annualized) | 3.97% |
| Geometric Mean (monthly) | 0.32% |
| Geometric Mean (annualized) | 3.90% |
| Volatility (monthly) | 1.06% |
| Volatility (annualized) | 3.67% |
| Downside Deviation (monthly) | 0.56% |
| Max. Drawdown | -4.31% |
| US Market Correlation | 0.01 |
| Beta(*) | 0.00 |
| Alpha (annualized) | 3.89% |
| R2 | 0.00% |
| Sharpe Ratio | 0.72 |
| Sortino Ratio | 1.26 |
| Treynor Ratio (%) | 1,775.71 |
| Calmar Ratio | 0.72 |
| Active Return | -4.53% |
| Tracking Error | 14.52% |
| Information Ratio | -0.31 |
| Skewness | 0.82 |
| Excess Kurtosis | 6.49 |
| Historical Value-at-Risk (5%) | -1.22% |
| Analytical Value-at-Risk (5%) | -1.42% |
| Conditional Value-at-Risk (5%) | -2.01% |
| Upside Capture Ratio (%) | 9.87 |
| Downside Capture Ratio (%) | -9.56 |
| Safe Withdrawal Rate | 7.69% |
| Perpetual Withdrawal Rate | 1.74% |
| Positive Periods | 114 out of 185 (61.62%) |
| Gain/Loss Ratio | 1.45 |
(Source: PortfolioVisualizer.com)
When you are building out a whole portfolio, you need assets that are not correlated to each other. The beta of this ETF comes in at .00%. This means the ETF is not moving at all with the equity markets. You also need to see what is the Max potential loss you could have suffered over the past 15 years. The AGG has only produced a max drawdown of -4.31%. Equities over the same time are around -50.8%. This is why an investor needs to own bonds long term, and in a passive fund like the AGG.
Summary
When looking at where you should allocate long-term capital, AGG and the aggregate index continues to slow and steady perform for investors. Regardless of what the Federal Reserve does in the short-term with the Fed Funds rate, it pays to own bonds passively long-term. With the risks to the global economy rising, and the risk of the Federal Reserve lowering rates to respond to this, it could be quite easy for investors to allocate more capital here instead of equities. Since 1980, AGG and its appropriate index has had 36 positive years out of the past 39. The iShares Core Aggregate Index ETF could be the anchor of your portfolio in an upcoming equity market storm.
Disclosure: I am/we are long AGG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Ortner Capital consults clients who own AGG. These opinions are that of Mr. Josh Ortner, CTFA. Please consult a certified professional on your overall financial picture before making any transactions based on this article.
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