AOK - AOK: A Retired Investor's 401k Aggregator

2024-01-18 15:21:54 ET

Summary

• The iShares Core Conservative Allocation ETF is a 70% fixed income, 30% equities fund that seeks to track the performance of a conservative stock-bond allocation strategy.
• The fund's composition includes fixed income ETFs such as the iShares Core Total USD Bond Market ETF and the iShares Core International Aggregate Bond ETF.
• Buying fixed income at the current macroeconomic juncture is seen as a viable option, with rate cuts priced in for 2024 and the potential for positive price performance.
• AOK has very limited growth potential via its low 30% equity sleeve and thus represents a conservative income play.

Thesis

The iShares Core Conservative Allocation ETF ( AOK ) is an exchange-traded fund from iShares/BlackRock. The vehicle seeks to track the investment results of the S&P Target Risk Conservative Index which is composed of equity and fixed income funds intended to represent a conservative target risk allocation strategy. As per its literature:

The S&P Target Risk Conservative Index is designed to measure the performance of conservative stock-bond allocations to fixed income, seeking to produce a current income stream and avoid excessive volatility of returns. Equities are included to protect long-term purchasing power.

The vehicle has an approximate 70% fixed income, 30% equities allocation, and complements a suite of products which we have covered before on the platform. Namely, we looked before at the following 'sister' funds:

• The iShares Core Growth Allocation ETF (AOR) which we covered here , and represents a classic 60% Equity / 40% Fixed Income allocator.
• The iShares Core Aggressive Allocation ETF ( AOA ) which we covered here , and represents a more aggressive 80% Equities / 20% Fixed Income allocator.

AOK complements that suite of products, taking an overweight positioning on fixed income. In this article, we are going to discuss the fund composition, its viability in today's macroeconomic environment and our views on the best suitability for this fund.

Fund composition - emphasizing fixed income

As per its index definition, the ETF has an overweight positioning in fixed income:

The fund invests in other large ETFs to achieve its exposures. We are going to have a look at each of its components, but the rough macro allocation here is 70% Fixed Income, 30% Equities. The fund components have the following characteristics:

• The iShares Core Total USD Bond Market ETF ( IUSB ) is a fixed income ETF which offers investors a vertical slice of the U.S. fixed income market, with allocations across both investment grade and high yield issuers. The fund has a 5.8 years duration and a 4.4% 30-day SEC yield.
• The iShares Core International Aggregate Bond ETF ( IAGG ) is a global take on fixed income, being composed of global non-U.S. dollar-denominated investment-grade bonds. The fund has a 6.6 years duration and a 3% 30-day SEC yield.
• The iShares Core S&P 500 ETF ( IVV ) is an equities ETF that replicates the S&P 500's performance.
• The iShares Core MSCI International Developed Markets ETF ( IDEV ) seeks to track the investment results of an index composed of high dividend-paying equities in non-U.S. developed markets.

Now is the time to buy fixed income

After an unprecedented rise in interest rates in a short period of time, the market is now pricing in rate cuts:

The above represents the path of Fed Funds as priced by Fed Funds futures and aggregated by Bloomberg via their <WIRP> function (World Interest Rate Probabilities). Mind you the Fed Funds futures market is an active one, with probabilities changing daily, but the clear take-away here is that 2024 will undoubtedly see rate cuts in our view.

Fixed income is the beneficiary of lower rates, with a rough estimation equal to the fund's duration in terms of gain for 100 bps in cuts. So for IUSB above (the main component for the ETF), 100 bps in rate cuts will result in a 5.8% gain (assuming a parallel shift lower in all the nodes of the yield curve). The number of cuts and exact movement of the yield curve is debatable, but what is not debatable is the fact that fixed income will record a positive price performance from potentially lower rates in 2024. In the above example, the total gain for IUSB in 2024 would equate to 5.8% from PV moves and 4.4% from its dividend yield, thus providing for a total return in excess of 10%.

Our house view is therefore centered around the fact that rate hikes are behind us, and buying fixed income at the current juncture of the macrocycle is the appropriate undertaking.

What are the risks of being overweight fixed income

Being overweight fixed income (investment grade fixed income here) basically caps the potential total returns. Equity sits at the bottom of the capital structure and thus tends to have high growth percentages in bull markets. Investment grade fixed income on the other hand has a very capped annual total return. Most of the gains are received via the income yield, with a certain percentage also gained via the duration profile when rates are moving lower (today's environment).

AOK's total return profile will therefore be much more muted when compared to the classic 60/40 portfolio. However, its risk will also be much lower, with a very low volatility profile. The fund has a 6.4% annualized volatility, even after factoring in having passed one of the most turbulent times in the history of fixed income. Historically the fund posts 4% to 5% annual total returns during periods when rates are not rising:

If we exclude the years when rates were rising (2015, 2018 and 2022), the ETF yields total return performances of 4% and above. Expect a similar return profile in the future as well. The highest gains are obtained when rates are moving lower (2019, 2020) and the equity market rallies.

Outside of 2022, which saw an unprecedented rise in interest rates, the fund has a very conservative drawdown profile, which rarely exceeds -5%:

The fund's name therefore references the fact that investment grade fixed income has very contained drawdown profiles, absent a high inflationary environment when rates are raised substantially. Most of the fund's 2022 drawdown came from fixed income.

Expect the future to look very similar, with the ETF returning to drawdown levels of -5%, all while clipping the yield.

Who should be interested in AOK

While we cannot tell an investor if they should or should not be interested in a ticker, the particularities of AOK make it most suitable (in our opinion) for retired investors looking for steady, low volatility income. AOK is not going to offer you 8% annual total returns with a 20% standard deviation, but what it is going to do is provide for a rough 5% annual total return for the next five years with an extremely low annualized volatility which will go below 6%.

Investors who are not already retired would be best suited to look at AOR or AOA, since they offer better long-term returns via their larger equity sleeves. At the same time, those funds are more volatile, and provide for a lower 30-day SEC yield.

Conclusion

AOK is an ETF from the iShares/BlackRock funds family. The vehicle represents a 70% fixed income / 30% equities aggregator, via a portfolio of ETFs. The fund's fixed income allocation focuses on investment-grade bonds, thus capping the overall potential yields for the fund. The ETF is a very conservative take on the market via its large 70% fixed income sleeve, and in our opinion is most suitable as a 401k aggregator for a retired investor. With fixed income having experienced a historically large drawdown in 2022 on the back of violently rising rates, the macrocycle points towards investors buying fixed income at this juncture with rate cuts priced in for 2024. We are of the opinion that AOK will be able to deliver annual total returns in excess of 5% for the next three years, with an annualized volatility below 6%.

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