BOND - BOND: Diversified Investment-Grade Bond ETF Uncompelling Value Proposition

2023-10-12 08:28:49 ET

Summary

• BOND has a growing 3.8% dividend yield, low credit risk, but moderate interest rate risk.
• It seems like a reasonable investment for more conservative income investors and retirees, but compares unfavorably to some of its peers.
• An overview of the fund follows.

I last covered the PIMCO Active Bond Exchange-Traded Fund (BOND), an actively-managed bond ETF, in mid-2022. In that article, I argued that BOND's diversified holdings and above-average yield made the fund a buy. Returns have been quite mediocre since, with the fund seeing losses of around 4.0%. Losses were almost entirely due to higher rates and lower bond prices. BOND did outperform its benchmark, the iShares Core U.S. Aggregate Bond ETF (AGG), which suffered losses of around 4.7%.

Right now, BOND offers investors a growing 3.8% dividend yield, very low credit risk, but moderate interest rate risk. The fund seems like a reasonable investment opportunity for more risk-averse long-term investors and retirees, but compares unfavorably to several variable rate ETFs. These include the Janus Henderson AAA CLO ETF (JAAA) and the Janus Henderson B-BBB CLO ETF (JBBB). As such, I would not be investing in BOND at the present time.

BOND - Basics

• Investment Manager: PIMCO
• Dividend Yield: 3.82%
• Expense Ratio: 0.55%
• Total Returns CAGR (Inception): 2.36%

BOND - Overview and Benefits

Diversified High-Quality Holdings

BOND is an actively-managed ETF administered by PIMCO. Although the fund is actively-managed, it attempts to hold a diversified portfolio of assets. BOND currently invests in over 1000 holdings from most of the major bond sub-asset classes. It focuses on mortgage-backed securities, with significant investments in treasuries and investment-grade bonds. Current asset allocations are as follows.

BOND's diversification reduces portfolio risk and volatility, and is a significant benefit for the fund and its shareholders.

The fund focuses on higher-quality securities, with very small investments in high-yield bonds, emerging markets, and similar. Almost half of the fund's holdings are rated AAA, or are issued by the U.S. Federal government. Credit ratings are as follows.

BOND's credit ratings are indicative of safe, resilient issuers, with ample financial capacity to meet their financial obligations. Default rates are low, even when economic conditions are tough. This serves to significantly reduce losses during downturns and recessions, as was the case in 1Q2020. BOND only suffered 1.0% losses during the quarter, very small on an absolute basis.

BOND's high-quality holdings reduce portfolio risk and volatility, and minimize losses during downturns, two important benefits for the fund and its shareholders.

Although BONDs are of very high quality, most of the larger, more well-known bond ETFs are of higher quality still. AGG, for instance, has higher treasury allocations.

Treasuries tend to perform particularly well during downturns and recessions, as the Federal Reserve tends to cut rates during these, leading to higher treasury prices. Treasuries also experience a positive flight-to-quality effect during most downturns. Due to this, the fund slightly underperformed AGG in early 2020, significantly underperformed treasury benchmarks. BOND still outperformed other bond sub-asset classes, however.

Although BOND's holdings are of very high quality, the fund is marginally riskier than bond indexes, and quite a bit riskier than treasury indexes.

Good Performance Track Record

BOND's performance track-record is quite good, with the fund outperforming its benchmark since inception, and for basically all relevant time periods. I'm excluding data prior to 2014 in the table below, as the fund's strategy was materially different before that.

BOND has also tended to outperform relative to treasuries and investment-grade corporate bonds, although a bit less so for the latter. It has underperformed high-yield corporate bonds, however, due to their higher yields. It has underperformed t-bills for quite a few years too, due to their low interest rate risk. Fund performance is as follows.

In my opinion, and considering the above, BOND's performance track-record is reasonably good, if not outstanding.

Although BOND does have its benefits, it compares unfavorably to short-term and variable rate securities in several key ways. Let's have a look.

BOND - Disadvantages Relative to Short-Term / Variable Rate Securities

Lower Dividends

BOND currently offers investors a 3.8% dividend yield. It might have been a reasonable yield on the ZIRP era, less so with Federal Reserve rates at +5.0%, their highest levels in two decades. BOND's dividends compare unfavorably to those of t-bills, floating rate treasuries, AAA-rated CLOs, and other high-quality variable rate securities.

BOND's dividend growth has been much weaker too, as the fund must wait until its existing, low-yield portfolio matures to replace it with newer, higher-yielding bonds. The process is much quicker for t-bills, which take a few months to mature at most. The same is true for variable rate securities, which tend to reset their coupon rates every quarter.

BOND's comparatively low dividends are an important disadvantage vis a vis its short-term and variable rate peers.

Higher Rate Risk

BOND focuses on medium-term bonds and treasuries, with the fund sporting an average duration of 6.5 years.

BOND's duration is about average for an investment-grade bond fund, but much higher than that of t-bill and variable rate funds, most of which have negligible rate risk. Expect BOND to underperform these funds when rates rise, as has been the case since early 2022.

Importantly, expectations of future rates matter too, as investors use these to price medium-term and long-term bonds. As such, investors should expect BOND to underperform if investors expect rates to be higher (for longer) from here on out. As an example, the fund has underperformed these past few weeks, in the aftermath of hawkish guidance from the Fed .

BOND has more rate risk than t-bills and other variable rate securities, an important disadvantage. In my opinion, although BOND's rate risk is not excessive , it is unnecessary , with the market offering investors lots of safer, higher-yielding choices.

BOND - Other Considerations

BOND sometimes uses modest amounts of leverage, to boost dividends and returns. Risks and volatility also increase, obviously. From looking at their latest report, BOND currently has effectively no leverage. It seems to have committed to buying a significant number of MBS, which gets recorded as a liability in the balance sheet.

Conclusion

BOND offers investors a growing 3.8% dividend yield, very low credit risk, but moderate interest rate risk. Although the fund is a broadly reasonable investment, it compares unfavorably to short-term and variable rate securities. As such, I would not be investing in BOND at the present time.

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