Barclays Aggregate Index-Where to go?

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In our last piece, we described the problems associated with exposure to products that passively track the Barclays US Aggregate Index such as the I-Shares product(AGG). There is simply not a reasonable risk to reward under most circumstances and therefore we heavily favor active management.

Given the heavy weight in government debt in this index and most of the ETFs that track them, we will introduce a couple managers that similarly use the Barclays US Aggregate Index and who are heavily weighted toward Treasuries or Mortgage Backed Debt.

One of the issues with regard to fund selection in this area is the often times confusing labels. We have similar funds named, “intermediate bond”, “total return”, “core”, “core plus” etc. Even within each of these categories, there is much variance in the strategies.

The mandate can vary at a few levels that include; security type, credit quality, duration management and regional focus. To put any relative comparison in perspective, a quick review might provide some perspective.

As we mentioned in past posts on core fixed income, it is important to dig into the details to determine if the fund is truly a substitute for representation by the Barclays Aggregate Index. We found TCW to posses excellent management skills mainly within the realm of mortgage backed securities. That fund could be potentially used a strategic holding as exposure to a value added manager within a specific bond asset class. It should not be used as a broad based exposure to multiple markets to replace the I-Shares AGG due to its focused mandate.

GW&K Enhanced Core Bond Fund accomplishes outperformance vs the Barclays Aggregate Index differently than the TCW Total Return Fund. They add in a more active high yield opportunistic approach to enhance risk-adjusted returns while they maintain a solid position in AAA rated Mortgage Backed Securities. They also weigh more heavily in those areas among the investment grade world that offer more relative value.

They have done a nice job over the last few years and could have served as a reasonable substitute for the -I-Shares AGG product as they were able to adjust duration, credit quality and sector weights successfully. Their current yield stands at around 2.5%.

Another fund that has done well over the last few years on a relative and absolute basis v the Barclays Aggregate Index is the Aston TCH Fixed Income Fund. While they hold a lot of Mortgage Backed Bonds, they have achieved their numbers in part through an overweight to corporate debt below AAA as they opportunistically look for value in the BBB area of the credit spectrum. The dilemma here is that corporate and mortgage backed debt may be arguably fully valued so gains from here may be difficult to come by. They have a slightly higher duration than the AGG product and a 74 basis points yield advantage.

Thus far we have found at least one manager who may be able to fill the role of a value added manager in the mortgage backed space and two managers who have in the past been successful at beating their main benchmark.

While we support active management, it is difficult to see how theses funds will achieve the same success in the future since many fixed income classes are fully to overvalued. While we have looked at these funds it may be helpful to speak generally about various strategies and the potential benefits they possess as well as the drawbacks.

It may be difficult to find one manager who is able to be a Barclays Aggregate representative for your fixed income allocation. One reason is that it is simply difficult to find value in many spaces domestically. A US investment grade portfolio has limitations with regard to the amount of yield and capital appreciation available and a manager that tracks this will likely find it difficult although not impossible to outperform.

It strikes us at Zenith that a more unique approach is warranted. One that potentially has a wider mandate with regard to geography, security type and credit rating as well as very nimble duration management.

Here are a few strategies to begin to consider as the opportunity set that tracks the Barclays Aggregate may be limited for a while.

• Flexible Income Funds-The mandate is typically more nimble and the scope is wider.

• Global Bond Funds-The mandates vary but these managers are able to attempt to secure value domestically and to be able to search around the globe. This can involve multiple currencies and emerging markets. Each introduces their own risks but allows for a larger opportunity set.

• Unconstrained-These funds are in most cases the most nimble with regard to security selection, geographic reach and duration management. Some actually hold a negative duration. That can certainly work against the investor if rates decline.

We are convinced that a methodical move away from a core mandate around the Barclays Aggregate is one that needs to be taken over a reasonable time frame. Now would be a great time to internally assess your firms risk objective and what areas of the global bond market you are willing to explore for a portion of the bond portion of your portfolio.

We can help you through this process by taking a look at you current manager in terms of their process and if that process if conducive to future results. The high risk adjusted numbers for these managers over the last few years will likely be very difficult to achieve in the future unless their mandate and process are appropriately nimble.

Again to aid in this process we can sort through the various bond fund labels and how each may work to help or hurt your portfolio.

Thanks again for your time.


Tom Koehler-CIO


Bond Market Update

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The bond market for the most part has done reasonably well this year as the broad US market has provided a return of approximately 3.68%.

This is the return on the Barclay’s US Aggregate and one instrument that represents this large market is the I-Shares ETF (AGG). We have written in the past about using passive ETFs as a strategic holding. Generally we have viewed them with caution at best given the limitations that most possess.

A placement in this product provides you with exposure to an investment grade portfolio with most of the credit at the top end of this spectrum. This is due in large part to the heavy weight to Treasury Securities. They comprise 37% of the portfolio while Mortgage Backed Debt is about 27%. That is a large bet on steady to declining interest rates as the overall duration is 5.18 through June 30th.

As a review, this means that the fund can go down 5.18% for every 100 basis point move up in interest rates. 200 basis points and clients will wonder what happened to their “safe” money.

Even if rates remain absolutely steady, a yield of 2%, is hardly compensation for a fund with this amount of interest rate risk and the potential for a credit shock that would send the prices of even investment grade debt tumbling.

We feel at Zenith that it is difficult to paint a broad brush across the entire bond market for a strategic placement as their are a lot of sub-segments within this market.

Treasuries, mortgage-backed debt, municipal bonds and high yield are just a few in a very dynamic and diverse market. We recommend that firms build out their fixed income exposure with a group of managers with unique insight and management style.

While this will not come close to guaranteeing a full proof way to avoid losses in bonds, it will enable your firm to capture the value added provided by top managers in various categories.

Next week we will present a couple managers who we feel should be up for consideration given their management skills and risk control.


Tom Koehler-CIO

Commodities….Take a close look at them. ETFS Part three

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Real Return Series ETFs Piece #3

In our introductory piece we outlined the commodity asset class and explain some of the unique characteristics inherent in futures based products specific to commodities.

There are many products available and given the large variance of performance, it is very important to examine the construction methodology and assess the uniqueness of each.

FTGC-First Trust Global Tactical Commodity Fund-Active $183 Million AUM

Futures contract based
Zenith insight-This manager utilizes volatility studies to determine risk and position levels. They actively rebalance at least monthly to mitigate risk and volatility and the composition of the portfolio will change and differ to a large degree from the benchmark.

The benchmark is the Bloomberg Commodity Index and they have beaten it for the short time they have been in existence especially YTD by a wide margin. They have the potential but no guarantee to be able to mitigate contango.

GCC-Greenhaven Continuous Commodity Index-Passive $360 Million AUM

Futures contract based
Zenith insight-This ETF seeks to passively track its index through daily rebalancing to keep the weightings at 1/17 of the portfolio. While there is little active process, the adherence to a different index is refreshing. Typically and early in the game, funds had as their benchmark, the DJ-UBS Commodity Index or the Goldman Sachs energy heavy index.

They manage around the Thompson Reuters Continuous Equal Weighted Index which means that some of the energy heavy bias in other indexes is mitigated as agriculture is increased in percentage in addition to metals. They do not have much ability to mitigate the effects of contango in the portfolio.

GSG-I-Shares GSCI Commodity Index Trust-Passive $1.1Billon AUM

Futures Contract Based
Zenith Insight-This ETF lacks inspiration in a few ways. First, it seeks to track a very energy heavy Goldman Sachs Index and does not offer much in terms of value added tactics. This should be evaluated and replaced with a more dynamic investment.

DBC-Powershares DB Commodity Tracking Fund-Passive $5.6Billion AUM

Futures Contract Based
Zenith Insight
This fund similar to GSG has little appeal in the weighting scheme as the weights are typically going to favor energy and specifically oil. They do however have the structural ability to invest in contracts beyond the near month to help mitigate the effects of contango.

It tracks the DBIQ Optimum Yield Commodity Index which allows for this flexibility. The results have been reasonable and potentially worth a look.

CMDT-I-Shares Commodity Optimized Trust-Passive $13Million AUM

Futures Contract Based
Zenith Insight
This fund was created we feel in part due to its sister product mentioned above that lacks a dynamic method to deal with the effects of contango. It does not possess a unique weighting methodology.

Bloomberg Roll Select Commodity Index is the chosen benchmark that structurally allows for some contango mitigation.

USCI-United States Commodity Index Fund-Passive $646 Million

Futures Contract Based-but allows for non-futures exposure
Zenith Insight
This fund deserves consideration as it utilizes a unique benchmark that is equally weighted and rebalanced on a monthly basis. Regular rebalance mechanisms are important as this is a dynamic asset class.

The benchmark is the SummerHaven Dynamic Commodity Index Total Return℠ (SDCITR) is an index designed to reflect the performance of a portfolio of 14 commodity futures. This ETF deserves attention.

Our goal at this juncture was to familiarize your firm with the various ETF products available with some assessment and directional guidance.

We would like your investment committee to take away a couple major points as you examine your commodity exposure.

a. Contango/Backwardation-Please take the time to examine these two characteristics of futures based products prior to making a placement.
b. Some of these funds are more capable of handling this issue and it is very important to decipher this.
c. Index benchmark selection can have major implications for risk adjusted and absolute performance. As we pointed out, some of these ETFs possess a more dynamic weighting scheme that holds the potential for outperformance.

We will take the time to outline some of the Exchange Traded Notes (ETNS) in our next piece on commodities. This will help drive the decision between ETFs and ETNs for investment committees. It will also help illustrate reasonably obvious examples of funds that should be sold and replaced.

Lastly, with most commodity indexes and products experiencing reasonable to robust performance year to date, this is a VERY good time to examine your holdings in this area.


Tom Koehler-CIO

Inflation series part four-The assessment

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ZPS Inflation Linked Notes Assessment-Part Four

This four part series is designed to aid wealth management firms, pension consultants and family offices with their decision making process within the real return segment.

The series began with an inflation review that included the current state of the market in addition to TIPs characteristics and unique valuation metrics.

We proceeded in piece two to outline the various ways to obtain exposure to inflation linked notes using ETFs as our examples. Then in piece three, we delved into actively managed mutual funds and gave each a score for suitability in a portfolio. Most, including some popular names with massive AUM did not make the cut.

As we wrap up the series with a description and rationale for our favored Zenith Score Fund, we set the stage with inflation rates globally.

Region/country CPI Month end YOY
US 2.13% up May 14
English 1.51% down May 14
European .40% down May 14
German .853% down May 14
Chinese 2.42% down June 14
Australian 2.9% March 14-Next End of July
Brazil 6.374% up June 14
South Africa 6.836% up May 14
France .691% up May 14
Japan 3.71% up May 14
India 7.018% up May 14
Mexico 3.753% up May 14
Iceland 2.238% down May 14
Canada 2.276% up May 14
New Zealand 1.50% April 14-Next end of July

These various inflation rates can help explain in part the differences in performance among the various funds. Since US inflation has been muted until recently, the ETFs such as WIP have outperformed over the last year. This is the ETF we did not recommend for a long term strategic placement and stick to this view despite its out-performance vs funds that focus solely on US TIPs. Our rationale is that the product was in the right place as (non-US) inflation was higher than US inflation in many cases.

WIP, the SPDR DB International Government Inflation-Protected Bond ETF produced a 8.26% return through 7/10/14 while TIP-I-Shares only produced a return of 3.8% largely due to its focus on US TIPS. ILB (Pimco’s active ETF) which has the ability to invest in a variety of global inflation indexed notes produced a 7.04% return.

Rather than choosing between US and non-US inflation, we feel that investors should embrace a manager with a broader opportunity set in order to take advantage of inflation investments on a global scale.

Mentioned above we like the Pimco Global Advantage Inflation Linked Fund (ILB). This fund combines active management within an ETF structure while continually assessing the entire global inflation linked bond opportunity set.

This opportunity set consists of the US, Developed Markets-ex US and emerging markets. Since some of the countries may have small markets, the manager of this fund has a threshold for liquidity and they also maintain a mostly investment grade threshold for inclusion in the portfolio.

It is important to note that their performance enhancers and detractors have a lot to do with the direction of real interest rates. We covered that topic in the first part of this series as the general goal is to garner high real yields and profit from a decline in those yields.

They do a reasonable job of finding value in real yields that are projected to fall and to underweight those that are suspected rise.

The combination of a wider global mandate with active management in a multi-currency portfolio is favorable to us here at Zenith and at least over the last year it is paid off vs at least a few actively managed funds.

We described and scored four funds in the third part of this series. ILB has provided a superior return over the last year in comparison to all of the reasonably mandate constrained funds. American Century, T-Rowe, Vanguard, Fidelity and Pimco all did worse in the open end space than ILB was able to accomplish in the ETF structure.

Within the mutual fund lineup we provided, American Century was the worst while the others struggled to post stellar results as well, again due to their muted mandate and opportunity set.

We highly suggest that your firm examine your inflation indexed notes exposure. Specifically, we recommend that you address the breadth of your managers’ opportunity set and how well they perform within that set.

As part of this vetting process, we encourage your firm to include ILB as one of the top contenders for your inflation indexed note exposure.

If you have any thoughts or questions with regard to this four part series, please reach out and we would be happy to help sort through this nuanced asset class.


Tom Koehler-CIO

Calvert Funds-SRI-ESG Part Two

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Socially Responsible Investments-Is there an SRI/ESG replacement for your large cap core fund?

In our last piece we introduced Calvert Investments based in Bethesda, MD and in this piece we would like to examine a couple of their main large cap funds within their Signature Series to start to determine if they are worthy enough to replace your current large cap core. As we mentioned, they focus on socially responsible investments and incorporate a proprietary screen in their selection process. Below are two of their in-house funds described in order to help determine if they deserve a place in your portfolio.

Calvert Funds-Their Signature Series

CISYX Calvert Social Index Fund $333Mill AUM

Description and Strategy

The Fund employs a passive management strategy designed to track, as closely as possible, the performance of the Calvert Social Index. The Fund uses a replication index method, investing in the common stock of each company in the Index in about the same proportion as represented in the Index itself. The Calvert Social Index measures the performance of those companies that meet the sustainable and socially responsible investment criteria and that are selected from the universe of approximately the 1,000 largest U.S. companies, based on total market capitalization, included in the Dow Jones Total Market Index.


This is an equity fund and as such will possess equity risk. Also, since this fund has as it’s a self-created index at Calvert, there is process and construction methodology risk. It is large cap and since they employ SRI screens, the composition of this fund will differ from other large cap indexes.

Their team then scores each companies adherence to seven major ESG criteria to include; governance and ethics, environment, workplace issues, product safety, human rights and Indigenous Peoples rights and community relations.

This screening process has lead to a high industry concentration in info tech, financials and health care. This is not inherently bad although industry concentration bets are typically best left to a seasoned active manager.

Risk-Adjusted Stats and performance

It trails it own benchmark and has little chance given its passive mandate. It has done well vs. large cap blend funds at times although it does not possess the level of consistency that we would like to see.  

Process and overall assessment

While this fund is reconstituted each year and they are able to sell securities based on their SRI criteria, we feel that this fund construction methodology can lead to sector concentration. While this can be beneficial if those industries are in favor, an active management style would be more appropriate as there will be times of value detraction. This firm’s belief that SRI criteria can enhance shareholder value over time may be the case but will need to be found in other more dynamic offerings.


Zenith Score-Low


CISYX Calvert Large Cap Core Fund $167 Mill AUM

Description and Strategy

The Fund employs an active management strategy designed to outperform the Russell 1000 index performance. The fund has a wider tracking error which gives it more opportunity to add values. Similar to its other funds, it rates companies on financial and ESG metrics.


This fund is an equity fund and as such will possess equity risk. It is large cap and since they employ SRI screens, the composition of this fund will differ from other large cap indexes.

While they include mid-cap companies, they begin by taking the top 1000 companies in order of market cap as their initial screen. This ends up being about 95% of all US companies.

Their team then scores each for the companies adherence to seven major ESG criteria to include; governance and ethics, environment, workplace issues, product safety, human rights and Indigenous Peoples rights and community relations.

This screening process has lead to a high industry concentration in info tech, financials and health care. This can help or hinder performance and at times this has helped performance although not consistently.

 Risk-Adjusted Stats and performance

It trails its benchmark and has little chance given its passive mandate. It has done well vs large cap blend funds at times although it does not possess the level of consistency that we would like to see.

 Process and overall assessment

While this fund is labeled a “large cap core”, there is simply not enough appeal in spite of the rigorous SRI/ESG process that the firm believes will enhance value over time.


Zenith Score-Low


Our overall assessment is that there may be room for SRI/ESG investments within a portfolio although these two funds would not warrant a placement as there are many others to explore that may offer better value either within Calvert or in additional SRI/ESG funds.


We will continue to examine Calvert in posts after the 4th weekend.




Tom Koehler, CIO