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Suitability
IShares Core Total US Bond Market tracks the Barclays Aggregate Bond Index, which is widely used as a proxy for the United States investment-grade bond market. AGG includes mortgage-backed securities, Treasuries, and corporates in its portfolio. This fund is broad enough to serve as the only fixed-income fund in many investors' portfolios.
The key advantage of aggregate bond funds is the built-in diversification benefits of owning different types of bonds. For example, the allocation to government bonds acts as a safety net for your portfolio. Government bonds are one of the only asset classes that have a negative correlation to equities. When stock markets perform poorly, government bond prices fare well. Conversely, when the economy is improving, corporate bonds tend to do well.
Bond prices have an inverse relationship to interest rates. If interest rates go up, bond prices go down. There have been very few sustained periods of rising interest rates during the last 30 years. With interest rates at or near all-time lows, investors today are rightly concerned that rates will rise in the future. AGG's portfolio has an average duration of around five years. This means that if interest rates rise 1%, the value of AGG's portfolio would decline by about 5%.
Investors seeking even broader exposure should note that the Barclays Aggregate Bond Index excludes Treasury Inflation-Protected Securities and floating-rate, tax-exempt municipal, convertible, foreign, and high-yield bonds.
Fundamental View
Securities backed by the U.S. government make up 70% of the fund's portfolio, so its returns are chiefly driven by movements in the U.S. Treasury market. As of this writing, the 10-year Treasury yields around 1.9%. Over the past three years, the 10-year Treasury has traded in a range between 1.4% and 4.0%. With current yields near all-time lows, the fixed-income space is not as attractive as it was just a few years ago.
With a current yield to maturity of 1.7%, investors may want to own AGG for one of two reasons. The first reason is that they think the U.S. may be heading down the same prolonged deflationary deleveraging process that has weighed on the Japanese economy for more than two decades. After Japan's stock market crashed in 1990, the country has seen persistent deflation and falling bond yields. The 10-year Japanese government bond reached a record low yield of 0.45% in 2003. If U.S. yields fall to similar levels, then bonds would appreciate in value--though not by much. The second reason to consider owning this ETF is for the diversification benefits it provides. Investment-grade bonds are one of the only asset classes that is negatively correlated with the stock market.
AGG has a current SEC yield of 1.7%. Based on this current yield, the best-case scenario for investors is total returns of just 1%-4%. There is very little margin for error in the bond market. Yields have very little room to head lower. The 10-year Treasury yield has already risen from a low of 1.4% touched in July 2012. The Congressional Budget Office projects the 10-year Treasury yield will be at 3.0% in 2015 and at 3.8% in 2016. If yields rise as projected, bond funds will have difficulty producing positive returns in the years ahead.
Portfolio Construction
IShares Core Total US Bond Market tracks the Barclays Aggregate Index, a proxy for the broad, investment-grade U.S. bond market. The fund does not hold every security in the index, but instead employs optimization techniques to carefully replicate the index's key characteristics, such as duration (a measure of interest-rate sensitivity) and credit quality. The index contains about 8,000 securities, of which this ETF holds about 1,800. By sector, the index fund's portfolio has a 44% weighting in U.S. government bonds, 30% in mortgage-backed securities, and 22% in U.S. corporates.
Fees
This fund's 0.08% expense ratio is very competitive. With assets greater than $15 billion and average trading volume totaling more than 1 million shares per day, AGG is one of the most liquid bond ETFs available.
Alternatives
Vanguard Total Bond Market ETF BND is the largest ETF in the category, with more than $17 billion in assets. It has an expense ratio of 0.10%.
SPDR Barclays Capital Aggregate Bond LAG, which charges an annual fee of 0.17%, is no longer competitive. Average daily turnover in LAG shares is a small fraction of that witnessed in either BND or AGG shares. And by taking a much smaller sample of its benchmark (about 1,000 securities as of this writing) LAG will potentially exhibit much larger tracking error than its peers.
Schwab U.S. Aggregate Bond SCHZ is a relatively new fund and the low-cost leader in the space with an annual fee of 0.05%. SCHZ is much smaller than its peers with about $400 million in assets. So far, the fund has offered good tracking, but it is still far less liquid than BND and AGG."
http://analysis.morningstar.com/analystreport/ear.aspx?Symbol=AGG&Country=usa
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