The ETF That Changed The Bond Game

The bulk of assets allocated to exchange traded funds reside in equity-based products, but fixed income funds are making significant contributions to the ETF industry's growth. Last year, investors allocated a record $84.34 billion to U.S.-listed bond ETFs.

As of Aug. 31, year-to-date inflows to bond ETFs trading in the U.S. are a still-impressive $51.5 billion.

Credit the iShares Core U.S. Aggregate Bond ETF AGG with starting a bond revolution in the ETF universe.

What Happened

Home to $55.91 billion in assets under management as of Sept. 18, AGG is by far the largest U.S.-listed fixed income ETF. The fund, which celebrates its 15^th anniversary this month, is about $20 billion larger than its closest rival.

AGG targets the Bloomberg Barclays US Aggregate Bond Index, one of the most widely followed fixed income benchmarks in the world. That gives iShares investors exposure to a massive number of bonds — 6,885 to be precise. Before the fund debuted, bond investors mostly depended on individual issues or actively managed funds.

“Instead, most people bought individual bonds or looked to actively managed funds for the bond portion of their portfolios,” BlackRock said in a recent note.

“While each approach has its uses, there can be downsides: bond buying can be cumbersome and costly, especially for smaller investors; active funds typically try to outperform the index by over-weighting higher-yielding sectors or adjusting duration (interest rate risk).”

Why It's Important

Various data points suggest the growth of fixed income ETFs will continue. A recent study by Greenwich Associates indicates a majority of institutional investors around the world would consider turning to bond ETFs for fixed income exposure. Liquidity challenges are among the reasons more institutional investors are embracing bond ETFs.

In the U.S., about 20 of the 100 largest ETFs by assets are bond funds. Year-to-date, two bond ETFs, including the iShares fund, are among the top 10 asset-gathering U.S. ETFs.

“The launch of the iShares Core U.S. Aggregate Bond ETF revolutionized and democratized bond investing,” said BlackRock. “It was the first ETF to provide all investors with a low-cost, transparent way to 'own' the world’s predominant fixed income benchmark.”

The iShares fund charges just 0.05 percent per year, or $5 on a $10,000 investment, making it one of the least expensive U.S. ETFs, fixed income or otherwise. That expense ratio is well below the stock's original expense ratio of 0.22 percent.

What's Next

AGG spurred the creation of rival funds and international equivalents, such as the $872.25-million iShares Core International Aggregate Bond ETF IAGG.

“Fifteen years ago, there were only a handful of bond ETFs. Today, there are more 1,200 of them, trading in a market worth $840 billion globally. AGG opened the door toward a more modern and transparent bond market,” according to BlackRock.

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