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By Thomas Boccellari | 05-14-2015 06:00 AM

2 Flavors for Core Bond Indexers

IShares Core Total USD Bond ETF takes on more credit risk for higher yield, while iShares Core U.S. Aggregate Bond sticks with higher-quality credits.

Tom Boccellari: The Barclays U.S. Aggregate Bond Index is one of the most widely benchmarked fixed-income indexes in the world. It provides investors with a broad array of U.S. listed fixed-rate investment-grade bonds and covers the U.S. government, agency, corporate, and securitized bond sectors. However, many active managers in the intermediate-term bond Morningstar Category invest in high-yield bonds and foreign debt to achieve extra yield or better total returns.

Investors looking for a passive offering that combines investment-grade, high-yield, and U.S.-dollar-denominated foreign bonds may consider iShares Core Total USD Bond Market (IUSB). Tracking the Barclays U.S. Universal Bond Index, it includes all of the constituents in the Aggregate Index; however, it also includes high-yield corporate, eurodollar, U.S.-dollar-denominated emerging-markets, 144A securities, and a broad swath of commercial mortgage-backed bonds that are excluded from the Aggregate Index.

Historically, the inclusion of riskier assets, such as high-yield bonds, has provided greater yield and better risk-adjusted returns than funds that track the Aggregate Index. However, investors should note that this fund may underperform during turbulent markets because of its increased credit risk.

Nevertheless, at 15 basis points, it is cheaper than the 85-basis-point average expense ratio charged by active managers in the intermediate-term bond category. That said, it is nearly double that of index funds that track the Aggregate Index.

For instance, iShares Core U.S. Aggregate Bond (AGG) charges only 8 basis points for exposure to the Aggregate Index. In addition to its low cost, investors may also consider AGG because of its high-quality tilt, which could help it perform better during turbulent markets than IUSB.

For investors comfortable with taking on incremental credit risk for greater yield and performance may consider IUSB. Risk-averse investors are likely best served using AGG.

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