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When it comes to portfolio construction, the word ‘core’ often gets used a lot by financial advisors and media. The idea is that this group of funds—often indexed/passively managed—serves as the base of a portfolio, driving long-term returns. When it comes to fixed income and bond investing, core often means the Bloomberg U.S. Aggregate Bond Index or the Agg for short.
However, the Agg isn’t perfect. Thanks to its static nature and how it’s constructed, there are some issues with the index. We saw those issues come to fruition last year as the Fed raised rates.
To that, a core-plus fund could be an interesting option for fixed income investors. By allowing managers to slightly tweak the Agg, better returns and higher yields can be found. It’s here that fixed income seekers can win.
Since its creation in 1986, the Bloomberg US Aggregate Bond Index has grown to become the de-facto benchmark for the bond sector. Billions of dollars now sit in vehicles tied to the index. For example, the iShares Core U.S. Aggregate Bond ETF (AGG) has more than $90 billion in assets alone. It’s easy to understand why the index is so popular. The Agg is designed to be representative of the entire investment-grade quality or better bond universe in the United States. This includes U.S. Treasuries, agency bonds, asset-backed securities, mortgage-backed securities, and corporate bonds. All in all, there are nearly 11,000 bonds included in the index.
But the Agg does have some limitations.
For starters, the index is market-cap weighted. For equities, market-cap may be a problem. But for fixed income it can be. The reason is that market-cap-based bond indexes are overweight based on the amount of debt outstanding. The firms with the most debt get a higher place in the index, which is counter-intuitive as you’re now holding the biggest debtors’ bonds. In the case of the Agg, that’s the U.S. government.
Then there is duration risk and yield to consider. We saw duration come into play as the Fed raised rates and the Agg sank by over 13% in 2022. Meanwhile, the focus on government bonds keeps the benchmark’s overall average yield low.
Ultimately, these issues can hurt portfolios.
This is where a core-plus bond fund can come into play. Core-plus bond funds allow their managers some flexibility and leeway when selecting securities. They still focus on intermediate investment-grade bonds, but are allowed to play with the index construction to build a portfolio outside of the Agg. So, if a manager feels that corporate bonds offer a better deal than Treasuries, they can buy them. If they are worried about duration, they can go down the ladder as the Agg includes bonds with at least one year left until they mature. And depending on mandate, core-plus managers can even hold some exposure to non-investment-grade debt.
By doing this, investors can have better returns, limit losses, and potentially have higher yields from their fixed income portfolio.
The proof can be in the pudding. The category is relatively new, with Morningstar only tracking it since 2019. Last year, core-plus bonds held their own versus the index and so far, this year, they’ve managed to produce additional returns over the index. The debt ceiling debacle has created additional appeal for corporate debt, which the category can be overweight. The same can be said for mortgage bonds, which are now producing very high yields as the housing mess has continued.
Looking ahead, recessionary forces and the Fed’s potential to pause and even cut rates could help on returns over the Agg.
Don’t forget to check all bond funds here
Perhaps the best way to use core-plus in a portfolio is to add it alongside a position in a passive Agg-tracking fund. This way, investors get the benefits for both styles of fund management. The key thing to focus on is the quality of the manager and fees. Top managers will outperform their index, while low fees will ensure that extra performance actually goes into your pocket. Investors also need to dig into the fund’s mandate to make sure the fund is just sticking to the Agg universe, if that’s what they want.
So, what funds to buy? Fixed income-focused shop Lord Abbett has top rated core-plus funds in the Lord Abbett Core Plus Bond (LAPLX), while the American Century Core Plus (ACCNX) is a prime top-rated example of a core-plus fund that allows managers to own some non-investment-grade debt. PIMCO’s world famous Total Return (PTTAX) is also considered a core-plus fund, but the focus also includes capital appreciation within the Agg’s universe.
The active ETF boom is another way core-plus is winning. The JPMorgan Core Plus Bond (ONIAX) is already a top-performer in the space. However, the JPMorgan Core Plus Bond ETF (JCPB), which is run the same way, has started to outperform its mutual fund sister. The key? Low expenses are helping it win. As more managers launch active ETFs, the core-plus bond space could get very competitive on fees, boosting investors’ returns. Other prominent players in the active space include State Street and Baird.
|Name||Ticker||Type||Active?||AUM||YTD Ret (%)||Expense|
|JPMorgan Core Plus Bond ETF||JCPB||ETF||Yes||$330 million||3.1%||0.4%|
|BlackRock Total Return Inv A||MDHQX||Mutual Fund||Yes||$18.6 billion||1%||0.74%|
|JPMorgan Core Plus Bond||ONIAX||Mutual Fund||Yes||$16.9 billion||1%||0.75%.|
|Calvert Green Bond A||CGAFX||Mutual Fund||Yes||$852 million||1%||0.73%|
|Baird Core Plus Bond Inst||BCOIX||Mutual Fund||Yes||$24.3 billion||0.8%||0.3%|
|PIMCO Total Return A||PTTAX||Mutual Fund||Yes||$62 billion||0.5%||0.81%|
|State Street Income Fund||SSASX||Mutual Fund||Yes||$1.58 billion||0.2%||0.17%|
|American Century Core Plus||ACCNX||Mutual Fund||Yes||$490 million||0.1%||0.56%|
|Lord Abbett Core Plus Bond||LAPLX||Mutual Fund||Yes||$428 million||-0.2%||0.68%|
For investors looking for more, core-plus bond funds could be the answer. The flexibility of their managers allows them to customize and overcome the issues with the Agg index. Going forward, this could be a big advantage given the current rate environment.