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What you need to know about bond indexing

Performance

Various bond index strategies, like iShares bond ETFs, have outperformed their Morningstar mutual fund categories across a broad range of sectors.

Similar to equity ETFs, many bond ETFs have delivered competitive returns relative to active strategies across a variety of sectors.

In general, we would expect an index exposure to deliver the “market return” which should reside near the median of active manager performance. However, many iShares Bond ETFs have performed reasonably well relative to the universe of active strategies, particularly after adjusting for fees.

As an example, within specific sectors such as investment grade, high yield, and emerging markets, certain bond ETFs have tended to be above median or even in the top quartile of performance in their respective Morningstar categories.

Bond ETF Morningstar Category percentile rankings

Like equities, an index strategy does not necessarily mean average returns

% Rank in Category
TickeriShares ETFUS MF Category1 Year5 Year10 Year
AGG iShares Core U.S. Aggregate Bond ETF Intermediate-Term Bond 49% 44% 63%
LQD iShares iBoxx $ Investment Grade Corporate Bond ETF Corporate Bond 30% 33% 24%
MUB iShares National Muni Bond ETF Muni National Intermediate 36% 33% 24%
TIP iShares TIPS Bond ETF Inflation Protected 54% 38% 28%
EMB iShares J.P. Morgan USD Emerging Markets Bond ETF Emerging Market Bond 67% 28% 39%
HYG iShares iBoxx $ High Yield Corporate Bond ETF High Yield Bond 61% 62% 74%

Source: Morningstar, as of 3/31/18. Based on pre-tax returns. The following number of funds were used for the 1, 5 and 10 year period percentile rankings. Intermediate Term Bond: 616, 419, and 235 funds. Corporate Bond: 57, 39, 29 funds. Muni National Intermediate: 182, 120, 72 funds. Inflation Protected Bond: 67, 52, 32 funds. Emerging Market Bond: 101, 43, 14 funds. High Yield Bond: 310, 192, 113 funds. Past performance does not guarantee future results.


Most active managers in the Morningstar Intermediate Term Bond Category benchmark against the Bloomberg Barclays U.S. Aggregate Bond Index, which is mainly comprised of very high quality securities such as U.S. Treasuries and Agency MBS. However, these managers tend to hold out-of-benchmark tilts to sectors such as high yield, emerging markets or lower quality securitized or structured investments. As yield is an important component in total return, these higher yielding tilts provide a means to outperform a high quality, low yielding benchmark such as the Aggregate, but they can also increase the correlation with equity investments.

Bond strategy correlations with S&P 500

Active managers have had higher correlation to equities versus broad bond indexes

Bond strategy correlations with S&P 500

Source: Morningstar as of 12/31/17. Time period measured from 1/1/00 – 12/31/17. Correlation measures how two securities move in relation to each other. Correlation ranges between +1 and -1. A correlation of +1 indicates returns moved in tandem, -1 indicates returns moved in opposite directions, and 0 indicates no correlation. Past correlations not indicative of future correlations.


A closer fit benchmark is the Bloomberg Barclays U.S. Universal Bond Index, investable via the iShares Core Total USD Bond Market ETF (IUSB), which also has a tilt towards high yield, and as a result, the potential for higher returns than the Aggregate.