Resorting To Managed Bond Funds For The Morningstar 401K ETF Clone (JNK, TIP, SHY, BSV, AGG, GVI)

MS ETF Clone with PTTRX – We are in the process of trying to replicate the performance of the Morningstar 401K plan with ETFs. We identified two weaknesses in the ETF portfolio — international equity and fixed income. In the last article we dealt with the international equity portion and now we deal with fixed income.

We reviewed performance for each of the funds that are coupled together by sub-class type.

Ticker  Name 5 year AR (%) 3 year AR (%) 1 year AR (%) ETF Score Mu Fund Score
(JNK)  SPDR Barclays Capital High Yield Bond 4.15 6.89 11.89 35%  
(PHIYX)  PIMCO High Yield Instl 5.51 6.10 7.11   33%
(PRRIX)  PIMCO Real Return Instl 5.40 4.34 5.44   28%
(TIP)  iShares Barclays TIPS Bond 4.10 2.46 4.06 20%  
(AGG)  iShares Barclays Aggregate Bond 5.28 5.05 3.76 27%  
(PTTRX)  PIMCO Total Return Instl 8.07 8.64 6.61   44%
(GVI) iShares Barclays Interm Govt/Credit    5.47 5.11 13%  
(LSBDX)  Loomis Sayles Bond Instl 6.35 4.82 8.32   35%
(PRWBX)  STABLEVALUE 3.96 3.07 (0.21)   16%
(SHY)  iShares Barclays 1-3 Year Treasury  3.65 1.99 1.07 15%  
(BSV)  Vanguard Short-Term Bond ETF   1.08 0.90 3%  
(VBISX)  Vanguard Short-Term Bond Index Inv 4.36 2.87 0.10   17%

We can see that in the fixed income sub-classes, the high yield bonds (NYSE:JNK), (PHIYX) and short term treasury (NYSE:SHY), (PRWBX) run neck and neck. There is a fair gap in the inflation protected bonds (NYSE:TIP) and (PRRIX) but the biggest gaps are in the short term bonds (NYSE:BSV), (VBISX), intermediate bonds (NYSE:AGG), (PTTRX) and multi-sector bonds (NYSE:GVI), (LSBDX).

We will look at these last three biggest culprits.

If we consider short term bonds, the problem is that the ETFs are all very new. It might be worth swappin in VCSH going forward but there just isn’t enough history yet so this is a watching brief to see how they perform:

Ticker  Name 5 year AR (%) 3 year AR (%) 1 year AR (%) Score
(VBISX)  Vanguard Short-Term Bond Index Inv 4.4% 2.9% 0.1% 17%
(CSJ) iShares Barclays 1-3 Year Cred   3.2% 2.1% 7%
(VCSH) Vanguard Short-Term Corp Bd Id     3.7% 4%
(SCPB) SPDR Barclays Capital Short Term     3.0% 3%

If we now look at the multi-sector bonds

Ticker  Name 5 year AR (%) 3 year AR (%) 1 year AR (%) Score
(LSBDX)  Loomis Sayles Bond Instl 6.4% 4.8% 8.3% 34.6%
(AGG) iShares Barclays Aggregate Bon 5.3% 5.3% 3.8% 27.7%
(BND) Vanguard Total Bond Market ETF   2.0% 2.3% 5.3%
(BIV) Vanguard Intermediate-Term Bon   2.4% 3.8% 7.5%
(PCEF) PowerShares Income Composite     9.7% 9.7%

We are again plagued with short histories and AGG performs reasonably well — however AGG is used to match PTTRX. Some of the newer ETFs may give better alternatives in future but there is nothing that closes the gap.

PTTRX has been a staple in many portfolios and has continued to do an outstanding job of delivering consistently high returns. Again, the ETF selections lack much history although there are some promising alternatives.

Ticker  Name 5 year AR (%) 3 year AR (%) 1 year AR (%) Score
(PTTRX)  PIMCO Total Return Instl 8.1% 8.6% 6.6% 44%
(ITR) SPDR Barclays Cap Interm Term     6.2% 6%
(VCIT) Vanguard Interm-Tm Corp Bd Idx     7.7% 8%
(CFT) iShares Barclays Credit Bond   5.1% 5.5% 13%
(CIU) iShares Barclays Intermediate   4.8% 4.8% 12%
(CORP) PIMCO Investment Grade Corp Bd       0%

Given this background, we decided to insert the retail version of PTTRX and LSBDX — PTTDX and LSBRX and deal with the additional fees and redemption periods. We can go back and further optimize the other fixed income but this was a big enough change that we thought we would see how it turned out.

Performance chart (as of Feb 28, 2011)

Performance table (as of Feb 28, 2011)

We can see that the addition of the managed bond funds does give us a point or two of additional returns. It is important to note that this is slightly higher during the downturn when fixed income becomes even more of a focus.

If we now compare this with the original Morningstar portfolio, we can see that we have closed the gap to a large degree. Remember that the ETFs are newer and so the simulation can only put the money into cash when the ETFs don’t exist.

Performance chart (as of Mar 1, 2011)

Performance table (as of Mar 1, 2011)

Portfolio Name 1Yr AR 1Yr Sharpe 3Yr AR 3Yr Sharpe 5Yr AR 5Yr Sharpe
Morningstar 401K ETF Clone-PID-PIZ-LSBRX-PTTDX Tactical Asset Allocation Moderate 15% 124% 11% 88% 14% 95%
Morningstar 401K ETF Clone-PID-PIZ-LSBRX-PTTDX Strategic Asset Allocation Moderate 15% 153% 3% 16% 6% 33%
Morningstar Inc 401K Plan Tactical Asset Allocation Moderate 21% 168% 12% 121% 14% 125%
Morningstar Inc 401K Plan Strategic Asset Allocation Moderate 13% 178% 3% 22% 5% 35%

We notice that the original portfolio has performed better with TAA in the short term but over the longer time horizons, the perfomances are much closer.

There is a danger that this is considered returns chasing — that we are bulding a portfolio based on history and not forward looking and there is some justification to that charge. In particular, more attention could be given to some of the newer fixed income ETFs as they build history. A reasonable middle ground seems to be to either add the new funds and allow styles rotation to bring them in when merited or to wait another year and see what the historical trail looks like.

Disclosure: MyPlanIQ does not have any business relationship with the company or companies mentioned in this article. It does not set up their retirement plans. The performance data of portfolios mentioned above are obtained through historical simulation and are hypothetical.

Written By The Staff Of MyPlanIQ.com  

LTI Systems, Inc. is the operator of MyPlanIQ.com and ValidFi.com. The founders of LTI Systems have extensive technology and business background in computer and semiconductor industries. They have been using the strategies provided by MyPlanIQ for their own personal retirement and taxable investments. The mission of LTI Systems is to make wealth management investment strategies that are used to be only accessible to institutions and high net worth individuals available to private investors with a fraction of flat cost and ease of use. The founders of LTI Systems, investors themselves, take pride in creating such a system and service for investors by taking the perspective from the investor side. They are using the system and the strategies for their own investment and align their interests with their customers.   

MyPlanIQ’s blog provides periodical articles to discuss issues related to retirement plans (401(k), 403(b) and IRAs), deferred compensation plans (457), college savings plans (529), taxable brokerage investment accounts, variable annuities and universal life insurance plans. It also covers investment strategies, specifically strategic and tactical asset allocation and investment products such as ETFs and mutual funds. In addition, it syndicates daily articles that are related to retirement planning, personal finance, investment strategies, annuities, insurance, college savings and market/economic outlooks. It provides a comment and discussion community for readers.

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